1
FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1997
Commission file number 333-26699
CORNERSTONE BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
TENNESSEE 62-1173944
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
5319 HIGHWAY 153
CHATTANOOGA, TENNESSEE 37343
(Address of principal executive offices and Zip Code)
(423) 877-8181
(Registrant's telephone number)
Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the past
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. Yes X No
--- ---
THE AGGREGATE MARKET VALUE OF THE SHARES OF COMMON STOCK HELD BY
NONAFFILIATES OF THE REGISTRANT AS OF MARCH 31, 1998 IS APPROXIMATELY
$10,789,000. (For purposes of this calculation only, all executive officers and
directors are classified as affiliates.)
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. OUTSTANDING AT MARCH 31, 1998,
COMMON STOCK, $1.00 PAR VALUE, 1,007,561.
Documents Incorporated by Reference: NONE
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Cornerstone Bancshares, Inc. ("Cornerstone"), a Tennessee corporation,
is a bank holding company registered under the Bank Holding Company Act of 1956,
as amended, and was formerly known as East Ridge Bancshares, Inc. Its
wholly-owned subsidiary, Cornerstone Community Bank, a Tennessee banking
corporation (the "Bank"), resulted from the merger of The Bank of East Ridge and
Cornerstone Community Bank effective October 15, 1997. Cornerstone provides a
variety of banking and financial services to businesses and individuals.
Cornerstone's headquarters and principal banking office is located at 5319
Highway 153, Chattanooga, Tennessee. It has branches located at 4154 Ringgold
Road (formerly the main office of The Bank of East Ridge) and 610 Georgia
Avenue, Chattanooga, Tennessee. It also leases space in which it operates two
branches in Foodmax Supermarkets. Cornerstone conducts its business as a
commercial bank, with special emphasis in retail banking, including the
acceptance of checking and savings deposits, and the making of commercial, real
estate, personal, home improvement, automobile and other installment and term
loans. It also offers collections, notary public services, escrow service and
other customary bank services to its customers.
The 1997 and 1996 statistical disclosures of Cornerstone under Guide 3
represent historical financial information presented on a pro forma basis as if
the merger of The Bank of East Ridge and Cornerstone Community Bank occurred as
of January 1, 1996. Guide 3 financial information presented on the pro forma
basis provides comparable data that is reasonable and meaningful to the combined
banking operations that began on the merger date of October 15, 1997.
EMPLOYEES
As of March 31, 1998, Cornerstone had approximately 44 full-time
employees. The employees are not represented by a collective bargaining unit.
Cornerstone believes its relationship with its employees to be good.
CUSTOMERS
It is the opinion of management that there is no single customer or
affiliated group of customers whose deposits, if withdrawn, would have a
materially adverse effect on the business of Cornerstone.
COMPETITION
All phases of Cornerstone's banking activities are highly competitive.
Cornerstone competes actively with nine commercial banks, as well as finance
companies, credit unions and other financial institutions located in its service
area, which includes Hamilton County, Tennessee.
SUPERVISION AND REGULATION
Cornerstone is a bank holding company within the meaning of the federal
Bank Holding Company Act of 1956, as amended (the "Act"), and is registered with
the Board of Governors of the Federal Reserve System (the "Board"). Cornerstone
is required to file with the Board annual reports and such additional
information as the Board may require pursuant to the Act. The Board may also
make examinations of Cornerstone and its subsidiaries. The following summary of
the Act and of the other acts described herein is qualified in its entirety by
express reference to each of the particular acts.
The Act requires every bank holding company to obtain the prior
approval of the Board before acquiring direct or indirect ownership or control
of more than 5% of the voting shares of any bank which is not majority owned by
Cornerstone. The Act prohibits a bank holding company, with certain exceptions,
from acquiring direct or indirect ownership or control of more than 5% of the
outstanding voting shares of any company which is not a bank and from engaging
in any business other than banking or furnishing services to or performing
services for its subsidiaries. The 5% limitation is not applicable to ownership
of shares in any company the activities of which the Board has determined to be
so closely related to banking or managing or controlling banks as to be a proper
incident thereto.
Subject to limited exceptions, the Act prohibits the direct or indirect
acquisition by a bank holding company or any of its subsidiaries of more than
five percent of the voting shares or substantially all of the assets of a bank
located outside the state in which the operations of its banking subsidiaries
are principally conducted, unless the acquisition is specifically authorized by
a statute of the state in which the bank to be acquired is located. The
Tennessee Reciprocal Banking Act was amended, effective January 1, 1991,
generally to permit nationwide reciprocal interstate banking.
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The Bank is an "affiliate" of Cornerstone within the meaning of the
Federal Reserve Act. This act places restrictions on a bank's loans or
extensions of credit to, purchases of or investments in the securities of, and
purchases of assets from an affiliate, a bank's loans or extensions of credit to
third parties collateralized by the securities or obligations of an affiliate,
the issuance of guarantees, acceptances, and letters of credit on behalf of an
affiliate, and certain bank transactions with an affiliate, or with respect to
which an affiliate acts as agent, participates, or has a financial interest.
Furthermore, a bank holding company and its subsidiaries are prohibited from
engaging in certain tie-in arrangements in connection with any extension of
credit, lease or sale of property or furnishing of services.
Under Federal Reserve Board policy, Cornerstone is expected to act as a
source of financial strength to its subsidiary bank and to commit resources to
support its subsidiary. This support may be required at times when, absent such
Federal Reserve Board policy, Cornerstone may not be inclined to provide it.
Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989
("FIRREA"), a depository institution insured by the FDIC can be held liable for
any loss incurred by, or reasonably expected to be incurred by, the FDIC after
August 9, 1989 in connection with (a) the default of a commonly controlled
FDIC-insured depository institution or (b) any assistance provided by the FDIC
to any commonly controlled FDIC-insured depository institution "in danger of
default." "Default" is defined generally as the appointment of a conservator or
receiver and "in danger of default" is defined generally as the existence of
certain conditions indicating that a default is likely to occur in the absence
of regulatory assistance. Under FDICIA (see discussion below) a bank holding
company may be required to guarantee the capital plan of an undercapitalized
depository institution. Any capital loans by a bank holding company to any of
its subsidiary banks are subordinate in right of payment to deposits and to
certain other indebtedness of such subsidiary bank. In the event of a bank
holding company's bankruptcy, any commitment by the bank holding company to a
federal bank regulatory agency to maintain the capital of a subsidiary bank will
be assumed by the bankruptcy trustee and entitled to a priority of payment.
The Bank is a member of the FDIC and is subject to examination and
regulation by that authority. The Bank is chartered under the banking laws of
the State of Tennessee and is subject to the supervision of, and regular
examination by, the TDFI.
The Tennessee Reciprocal Banking Act requires the filing of an
application with and the approval of the Tennessee Commissioner of Financial
Institutions to acquire a Tennessee bank or bank holding company.
Tennessee law was amended in 1990 to permit branch banking in any
county in the state. Prior to the amendment, statewide branching was possible
pursuant to a May 1988 federal court decision.
In December 1991, a major banking bill entitled the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA") was enacted, which
substantially revises the bank regulatory and funding provisions of the Federal
Deposit Insurance Act and makes revisions to several other federal banking
statutes. Among other things, FDICIA requires the federal banking regulators to
take "prompt corrective action" in respect of depository institutions that do
not meet minimum capital requirements. The Bank has capital levels well above
the minimum requirements. In addition, an institution that is not well
capitalized is generally prohibited from accepting brokered deposits and
offering interest rates on deposits higher than the prevailing rate in its
market and also may not be able to "pass through" insurance coverage for certain
employee benefit accounts. FDICIA also requires the holding company of any
undercapitalized depository institution to guarantee, in part, certain aspects
of such depository institution's capital plan for such plan to be acceptable.
FDICIA contains numerous other provisions, including new accounting, audit and
reporting requirements, termination of the "too big to fail" doctrine except in
special cases, limitations on the FDIC's payment of deposits at foreign
branches, new regulatory standards in such areas as asset quality, earnings and
compensation and revised regulatory standards for, among other things, powers of
state banks, real estate lending and capital adequacy. FDICIA also requires that
a depository institution provide 90 days prior notice of the closing of any
branches.
EFFECT OF GOVERNMENTAL POLICIES
Cornerstone and the Bank are affected by the policies of regulatory
authorities, including the Federal Reserve System. An important function of the
Federal Reserve System is to regulate the national money supply. Among the
instruments of monetary policy used by the Federal Reserve are: purchases and
sales of U.S. Government securities in the marketplace; changes in the discount
rate, which is the rate any depository institution must pay to borrow from the
Federal Reserve; and changes in the reserve requirements of depository
institutions. These instruments are effective in influencing economic and
monetary growth, interest rate levels and inflation.
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The monetary policies of the Federal Reserve System and other
governmental policies have had a significant effect on the operating results of
commercial banks in the past and are expected to continue to do so in the
future. Because of changing conditions in the national economy and in the money
market, as well as the result of actions by monetary and fiscal authorities, it
is not possible to predict with certainty future changes in interest rates,
deposit levels, loan demand or the business and earnings of Cornerstone or
whether the changing economic conditions will have a positive or negative effect
on operations and earnings.
Bills are pending before the United States Congress and the Tennessee
General Assembly which could affect the business of Cornerstone and the Bank,
and there are indications that other similar bills may be introduced in the
future. It cannot be predicted whether or in what form any of these proposals
will be adopted or the extent to which the business of Cornerstone and the Bank
may be affected thereby.
NET INTEREST INCOME
The following table sets forth weighted yields earned by Cornerstone on
its earning assets and the weighted average rates paid on its deposits and other
interest-bearing liabilities for the years ended December 31, 1997 and 1996.
December 31, 1997 December 31, 1996
------------------------------- --------------------------------
Interest Average Interest Average
Average Income/ Yields/ Average Income/ Yields/
(Fully taxable equivalent) (Dollars in thousands) Balance Expense Rates Balance Expense Rates
-------- -------- ------- -------- -------- -------
ASSETS:
Interest-earning assets:
Loans net of unearned income............................... $ 50,120 $ 5,292 10.56% $ 32,051 $3,498 10.91%
Other investments.......................................... 19,207 1,317 6.86% 15,049 929 6.17%
Interest-bearing deposits with banks....................... 713 39 5.47% 1,940 96 4.95%
Federal funds sold......................................... 3,447 189 5.48% 2,028 116 5.72%
-------- ------- -------- ------
Total interest-earning assets/interest income......... 73,487 6,837 9.30% 51,067 4,639 9.08%
-------- ------- -------- ------
Cash and due from banks.................................... 2,859 2,592
Other assets............................................... 5,413 3,275
Allowance for loan losses................................. (706) (402)
-------- --------
Total.................................................. $ 81,053 $ 56,532
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities:
Demand deposits............................................ $ 11,104 $ 247 2.22% $ 8,815 $ 213 2.42%
Savings................................................... 9,430 363 3.85% 8,000 263 3.29%
Time certificates.......................................... 43,705 2,703 6.18% 27,945 1,482 5.30%
-------- ------- -------- ------
Other borrowings........................................... -0- -0- 397 32 8.06%
-------- ------- -------- ------
Total interest-bearing liabilities/interest expense.... 64,239 3,313 5.16% 45,157 1,990 4.41%
-------- ------- -------- ------
Non interest-bearing demand deposits....................... 7,896 5,469
Other liabilities.......................................... 2,654 369
Shareholders' equity....................................... 6,264 5,537
-------- --------
Total.................................................. $ 81,053 $ 56,532
======== ========
Net interest earnings...................................... $ 3,524 $2,649
======= ======
Net interest on interest-earning assets................... 4.80% 5.19%
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LIABILITY AND ASSET MANAGEMENT
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and by
monitoring an institution's interest rate sensitivity "gap." An asset or
liability is said to be interest rate sensitive within a specific time period if
it will mature or reprice within that time period. The interest rate sensitivity
gap is defined as the difference between the amount of interest-earning assets
maturing or repricing within a specific time period and the amount of
interest-bearing liabilities maturing or repricing within that time period. A
gap is considered positive when the amount of interest rate sensitive assets
exceeds the amount of interest rate sensitive liabilities. A gap is considered
negative when the amount of interest rate sensitive liabilities exceeds the
amount of interest rate sensitive assets. During a period of rising interest
rates, a negative gap would tend to adversely affect net interest income while a
positive gap would tend to result in an increase in net interest income. During
a period of falling interest rates, a negative gap would tend to result in an
increase in net interest income while a positive gap would tend to adversely
affect net interest income.
The asset/liability committee, which consists of the chief executive
officer, president and four other directors are charged with monitoring the
liquidity and funds position of Cornerstone. The committee regularly reviews (a)
the rate sensitivity position on a three-month, six-month, and one-year time
horizon; (b) loans to deposit ratios; and (c) average maturity for certain
categories of liabilities.
Cornerstone operates an internal asset/liability management model. No
estimates of the impact of changing interest rates on historical or projected
earnings are available. The current level of interest rate risk can, however, be
inferred from maturity and repricing data. At December 31, 1997, Cornerstone had
a negative cumulative repricing gap within one year of approximately $25
million, or approximately 27% of total assets. This negative repricing gap
indicates that Cornerstone's future earnings may be adversely impacted by a rise
in market interest rates. Such an impact would primarily be felt in the
twelve-month period after a rise in rates.
The following tables represent an interest sensitivity profile for
Cornerstone as of December 31, 1997 and 1996. The tables represent a static
point in time and do not consider other variables, such as changing spread
relationships or interest rate levels. "Net repricing gap" is the difference
between total earning assets and total interest bearing liabilities repricing in
any given period and "cumulative gap" is the sum of the net repricing gap from
period to period. Interest-bearing demand, savings and money market account
deposits are presented as repricing in the earliest period presented.
December 31, 1997
---------------------------------------------------------------------------
Within After 3 months After 12 months
3 months Within 12 months Within 5 years After 5 years Total
-------- ---------------- --------------- -------------- ----------
(Dollars in thousands)
EARNING ASSETS:
Loans ............................................. $ 20,833 $ 9,077 $25,525 $ 5,155 $60,590
Investment securities ............................. 1,424 2,146 12,621 2,205 18,396
Other earning assets .............................. 702 -- -- -- 702
Federal funds sold ................................ 1,130 -- -- -- 1,130
-------- -------- ------- ------- -------
Total earning assets ..................... $ 24,019 $ 11,223 $38,146 $ 7,360 $80,818
======== ======== ======= ======= =======
INTEREST-BEARING LIABILITIES:
Interest-bearing deposits ........................ $ 39,232 $ 21,020 $12,324 $ -- $72,576
-------- -------- ------- ------- -------
Total interest-bearing liabilities ....... $ 39,232 $ 21,020 $12,324 $ -- $72,576
======== ======== ======= ======= =======
RATE SENSITIVITY GAP:
Net repricing gap ................................. $(15,143) $ (9,797) $25,822 $ 7,360 $ 8,171
Net repricing gap as a percentage of total
assets ............................................ (16.33)% (10.57)% 27.85% 7.94% 8.89%
Cumulative gap .................................... $(15,143) $(24,940) $ 811 $ 8,171
Cumulative gap as a percentage of
total assets .................................... (16.33)% (26.90)% 0.87% 8.89%
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December 31, 1996
--------------------------------------------------------------------------
Within After 3 months After 12 months
3 months Within 12 months Within 5 years After 5 years Total
-------- ---------------- --------------- -------------- ---------
(Dollars in thousands)
EARNING ASSETS:
Loans ..................................... $22,851 $ 2,537 $15,596 $ 403 $41,387
Investment securities ..................... 814 6,125 5,202 4,837 16,978
Other earning assets ...................... 1,206 -- -- -- 1,206
Federal funds sold ........................ 2,327 -- -- -- 2,327
------- -------- ------- -------- -------
Total earning assets ............. $27,198 $ 8,662 $20,798 $ 5,240 $61,898
======= ======== ======= ======== =======
INTEREST-BEARING LIABILITIES:
Interest-bearing deposits ................ $11,713 $ 16,922 $12,968 $ 15,107 $56,710
Other borrowed funds ..................... -- -- 364 -- 364
------- -------- ------- -------- -------
Total interest-bearing liabilities $11,713 $ 16,922 $13,332 $ 15,107 $57,074
======= ======== ======= ======== =======
RATE SENSITIVITY GAP:
Net repricing gap ......................... $15,485 $ (8,260) $ 7,466 $ (9,867) $ 4,824
Net repricing gap as a percentage of total
assets .................................... 21.60% (11.52)% 10.41% (13.76)% 6.73%
Cumulative gap ............................ $15,485 $ 7,225 $14,691 $ 4,824
Cumulative gap as a percentage of
total assets ............................ 21.60% 10.08% 20.49% 6.73%
Management has made the following assumptions in the above analysis: (i) Assets
and liabilities are generally assigned to a period based upon their earliest
repricing period when the repricing is less than the contractual maturity; (ii)
Investment securities available for sale are currently treated in the same
manner as comparable securities in the investment securities held to maturity
portfolio in that they are scheduled according to the earlier of their
contractual maturities or earliest repricing dates; and (iii) Interest-bearing
demand deposits, money market deposits and savings deposits that have no
contractual maturities are scheduled in the within 3 months category.
DEPOSITS
Cornerstone's primary sources of funds are interest bearing deposits.
The following table sets forth Cornerstone's deposit structure at December 31,
1997 and 1996.
December 31, December 31,
1997 1996
------------ ------------
(In thousands)
Non interest-bearing deposits:
Individuals, partnerships and corporations.. $ 9,184 $ 6,254
Certified and official checks .............. 89 377
------- -------
Total non interest-bearing deposits ...... 9,273 6,631
Interest-bearing deposits:
Interest-bearing demand accounts ........... 13,009 9,362
Savings accounts .......................... 9,879 9,377
Certificates of deposit, less than $100,000 35,736 27,862
Certificates of deposit, $100,000 or more... 13,952 10,109
------- -------
Total interest-bearing deposits .......... 72,576 56,710
------- -------
Total deposits ........................... $81,849 $63,341
======= =======
The following table presents a breakdown by category of the average
amount of deposits and the average rate paid on deposits for the periods
indicated:
December 31, 1997 December 31, 1996
----------------------------------- ---------------------------
(Dollars in thousands)
Non interest-bearing deposits .. $ 7,896 $ 5,469
Savings deposits ............... 9,430 3.85% 8,000 3.29%
Time deposits .................. 43,705 6.18% 27,945 5.30%
Interest-bearing demand deposits 11,104 2.22% 8,815 2.42%
------- -------
Total deposits ........ $72,135 $50,229
======= =======
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At December 31, 1997 and 1996, time deposits of $100,000 or more
aggregated approximately $14.0 million and $10.0 million, respectively. The
following table indicates, as of the dates indicated, the dollar amount of
$100,000 or more by the time remaining until maturity (in thousands):
December 31, 1997 December 31, 1996
---------------------------------- -----------------------------------
3 Months 3 to 12 1 to 5 3 Months 3 to 12 1 to
or less Months Years or less Months Years
------- ------------- ------- --------- ---------- -------
Time certificates ........... $4,251 $7,076 $2,625 $1,949 $3,952 $4,208
ASSETS
Management of Cornerstone considers many criteria in managing assets,
including creditworthiness, diversification and structural characteristics,
maturity and interest rate sensitivity. The following table sets forth
Cornerstone's interest-earning assets by category at December 31, 1997 and 1996.
December 31, 1997 December 31, 1996
----------------- -----------------
(In thousands)
Interest-bearing deposits with banks .......... $ 702 $ 1,206
Investment securities held to maturity ........ 10,780 15,053
Investment securities available for sale ...... 7,616 1,925
Federal funds sold ............................ 1,130 2,327
Loans:
Real estate ................................. 42,716 28,586
Commercial and other ........................ 18,789 12,801
------- -------
Total loans ............................... 61,505 41,387
Provision for loan losses ................. 915 497
------- -------
Loans, net .................................. 60,590 40,890
------- -------
Interest-earning assets ...................... $80,818 $61,401
======= =======
INVESTMENT PORTFOLIO
At December 31, 1997, obligations of the United States Government or
its agencies represented 27.0% of the investment portfolio. The following table
presents the composition of the book value (historical amortized cost basis) of
Cornerstone's investment portfolio at December 31, 1997 and 1996.
December 31, 1997 December 31, 1996
----------------- -----------------
(In thousands)
AVAILABLE FOR SALE:
U. S. Treasuries....................................... $1,451 $ 1,841
Obligations of U.S. Government agencies................ 3,664 4,157
States and political subdivisions...................... -- 951
Other securities....................................... 2,501 275
------- -------
Total available for sale........................ 7,616 7,224
------- -------
HELD TO MATURITY:
Obligations of U.S. Government agencies................ 6,235 6,705
States and political subdivisions...................... -- 1,907
Other investment securities............................ 4,545 1,142
------- -------
Total investment securities held to maturity ...... $10,780 $ 9,754
------- -------
Total investment portfolio........................ $18,396 $16,978
======= =======
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The following table presents the maturity distribution of the book
value and estimated market value of Cornerstone's investment portfolio at
December 1997 and 1996. The weighted average yields on these instruments are
presented based on final maturity.
December 31, 1997 December 31, 1996
-------------------------------------- ------------------------------------
Weighted Weighted
Book Estimated Average Book Estimated Average
Value Market Value Yield Value Market Value Yield
----- ------------ ----- ----- ------------ -----
(In thousands)
AVAILABLE FOR SALE:
U.S. Treasuries:
Due within 1 year .................... $ 1,047 $ 1,047 5.62% $ 599 $ 602 6.34%
Due after 1 year but within 5 years .. 401 404 6.28% 1,238 1,239 5.74%
------- ------- ------ ------
Total ............................ 1,448 1,451 5.80% 1,837 1,841 5.93%
------- ------- ------ ------
Obligations of U.S. Government agencies:
Due within 1 year .................... 2,326 2,357 6.05% 234 235 6.22%
Due after 1 year but within 5 years .. 1,097 1,107 6.84% 3,165 3,167 5.58%
Due after 5 years but within 10 years 200 200 7.50% 200 198 7.22%
Due after 10 years ................... 556 557 6.95%
------- ------- ------ ------
Total .......................... 3,623 3,664 6.37% 4,155 4,157 5.88%
------- ------- ------ ------
States and political subdivisions:
Due after 10 years ................... 937 951 5.32%
------ ------
Other investment securities:
Due within 1 year ................... 301 310 7.72%
Due after 1 year but within 5 years . 689 693 6.62%
Due after 5 years but within 10 years 698 703 6.76%
Due after 10 years .................. 786 795 6.76% 280 275 6.57%
Total ............................. 2,474 2,501 6.79%
------- ------- ------ ------
Total available for sale .......... $ 7,545 $ 7,616 6.39% $7,209 $7,224 5.85%
======= ======= ====== ======
HELD TO MATURITY:
U.S. Government agencies:
Due within 1 year .................... $ 3,504 $ 3,546 5.95%
Due after 1 year but within 5 years .. 2,731 2,734 5.36% 5,244 5,243 6.30%
Due after 10 years ................... 1,461 1,457 6.13%
------- ------- ------ ------
Total ........................... 6,235 6,280 5.69% 6,705 6,700 6.26%
------- ------- ------ ------
State and political subdivisions:
Due after 5 years but within 10 years 146 146 5.00%
Due after 10 years .................. 1,761 1,793 5.50%
------ ------
Total .......................... 1,907 1,939 5.46%
------ ------
Other:
Due within 1 year ................... 1,391 1,394 6.79% 913 916 7.43%
Due after 1 year but within 5 years . 2,585 2,586 6.82% 229 230 7.37%
Due after 5 years but within 10 years 145 146 6.89%
Due after 10 years .................. 424 430 6.55%
------- -------
Total ........................... 4,545 4,556 6.79% 1,142 1,146 7.42%
------- ------- ------ ------
Total held to maturity ......... $10,780 $10,836 6.16% $9,754 $9,785 6.24%
======= ======= ====== ======
Total investments ...... $18,325 $18,452 6.42% $16,963 $17,009 6.07%
======= =======
INVESTMENT POLICY
The objective of Cornerstone's investment policy is to invest funds not
otherwise needed to meet the loan demand of Cornerstone's market area to earn
the maximum return for Cornerstone, yet still maintain sufficient liquidity to
meet fluctuations in Cornerstone's loan demand and deposit structure. In doing
so, Cornerstone balances the market and credit risks against the potential
investment return, makes investments compatible with the pledge requirements of
Cornerstone's deposits of public funds, maintains compliance with regulatory
investment requirements, and assists the various public entities with their
financing needs. The president is authorized to execute security transactions
for the investment portfolio based on the decisions of the asset/liability
committee. All the investment transactions occurring since the previous board of
directors' meeting are reviewed by the board at its next monthly meeting, in
addition to the entire portfolio. The investment policy allows portfolio
holdings to include short-term securities purchased to provide Cornerstone's
needed liquidity and longer term securities purchased to generate stable income
for Cornerstone during periods of interest rate fluctuations.
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LOAN PORTFOLIO
The following table summarizes certain information concerning
Cornerstone's loan portfolio (in thousands):
December 31, 1997 December 31, 1996
------------------------------ ----------------------------
Amount % of Total Loans Amount % of Total Loans
-------- ----------------- -------- ----------------
Real estate loans:
Construction and land development...... $ 8,581 13.95% $ 5,561 13.44%
Secured by residential properties...... 13,152 21.38% 9,629 23.27%
Other real estate loans................ 20,983 34.12% 13,396 32.36%
------- -------
Total real estate loans.............. 42,716 69.45% 28,586 69.07%
Commercial and industrial loans.......... 12,373 20.12% 6,645 16.06%
Consumer loans........................... 6,241 10.15% 4,972 12.01%
All other loans.......................... 175 0.28% 1,184 2.86%
------- ------ ------- ------
Total loans.......................... $61,505 100.00% $41,387 100.00%
======= ====== ======= ======
The following tables set forth maturities of the loan portfolio and the
sensitivity to interest rate changes of Cornerstone's loan portfolio (in
thousands).
December 31, 1997
----------------------------------------------------------------------
Maturity Range
----------------------------------------------------------------------
One Year One Through Over
or Less Five Years Five Years Total
-------- ----------- ---------- -------
Real estate construction loans ... $11,453 $17,395 $ 716 $29,564
Real estate mortgage loans ....... 6,237 4,139 2,776 13,152
Commercial and industrial loans 7,548 3,594 1,231 12,373
All other loans .................. 5,587 397 432 6,416
------- ------- ------ -------
Total loans .................... $30,825 $25,525 $5,155 $61,505
======= ======= ====== =======
December 31, 1996
----------------------------------------------------------------------
Maturity Range
----------------------------------------------------------------------
One Year One Through Over
or Less Five Years Five Years Total
-------- ----------- ---------- -------
Real estate construction loans ... $10,218 $ -- $ -- $10,218
Real estate mortgage loans ....... 4,049 8,435 6,637 19,121
Commercial and industrial loans 2,459 3,918 268 6,645
All other loans .................. 746 4,427 230 5,403
------- ------- ------ -------
Total loans .................... $17,472 $16,780 $7,135 $41,387
======= ======= ====== =======
LOAN POLICY
All lending activities of Cornerstone are under the direct supervision
and control of the senior loan committee, which consists of the chief executive
officer, president, executive vice president and four other directors. The loan
committee enforces loan authorizations for each officer, decides on loans
exceeding such limits, services all requests for officer credits to the extent
allowable under current laws and regulations, administers all problem credits,
and determines the allocation of funds for each lending division. Cornerstone's
established maximum loan volume to deposits is 85%. The loan portfolio consists
primarily of real estate, commercial and installment loans. Commercial loans
consist of either real estate loans or term loans. Maturity of term loans is
normally limited to five to seven years. Conventional real estate loans may be
made up to 95% of the appraised value or purchase cost of the real estate for no
more than a thirty-year term. Installment loans are based on the earning
capacity and vocational stability of the borrower.
Management of Cornerstone periodically reviews the loan portfolio,
particularly nonaccrual and renegotiated loans. The review may result in a
determination that a loan should be placed on a nonaccrual status for income
recognition. In addition, to the extent that management identifies potential
losses in the loan portfolio, it reduces the book value of such loans, through
charge-offs, to their estimated collectible value. Cornerstone's policy is to
classify as nonaccrual any loan on which payment of principal or interest is 90
days or more past due except where there is adequate collateral to cover
principal and accrued interest and the loan is in the process of collection. No
concessions are granted and late fees are collected. In addition, a loan will be
classified as nonaccrual if, in the opinion of the
- 9 -
10
management, based upon a review of the borrower's or guarantor's financial
condition, collateral value or other factors, payment is questionable, even
though payments are not 90 days or more past due.
When a loan is classified as nonaccrual, any unpaid interest is
reversed against current income. Interest is included in income thereafter only
to the extent received in cash. The loan remains in a nonaccrual classification
until such time as the loan is brought current, when it may be returned to
accrual classification. When principal or interest on a nonaccrual loan is
brought current, if in management's opinion future payments are questionable,
the loan would remain classified as nonaccrual. After a nonaccrual or
renegotiated loan is charged off, any subsequent payments of either interest or
principal are applied first to any remaining balance outstanding, then to
recoveries and lastly to income.
The large number of consumer installment loans and the relatively small
dollar amount of each makes an individual review impracticable. It is
Cornerstone's policy to charge off any consumer installment loan which is past
due 90 days or more.
In addition, mortgage loans secured by real estate are placed on
nonaccrual status when the mortgagor is in bankruptcy, or foreclosure
proceedings are instituted. Any accrued interest receivable remains in interest
income as an obligation of the borrower.
Cornerstone's underwriting guidelines are applied to three major
categories of loans, commercial and industrial, real estate, which includes
residential, construction and development and certain other real estate loans
and consumer loans. Cornerstone requires its loan officers and loan committee to
consider the borrower's character, the borrower's financial condition as
reflected in current financial statements, the borrower's management capability,
the borrower's industry and the economic environment in which the loan will be
repaid. Before approving a loan, the loan officer or committee must determine
that the borrower is basically honest and creditworthy, determine that the
borrower is a capable manager, understand the specific purpose of the loan,
understand the source and plan of repayment, determine that the purpose, plan
and source of repayment as well as collateral are acceptable, reasonable and
practical given the normal framework within which the borrower operates.
CREDIT RISK MANAGEMENT AND RESERVE FOR LOAN LOSSES
Credit risk and exposure to loss are inherent parts of the banking
business. Management seeks to manage and minimize these risks through its loan
and investment policies and loan review procedures. Management establishes and
continually reviews lending and investment criteria and approval procedures that
it believes reflect the risk sensitive nature of Cornerstone. The loan review
procedures are set to monitor adherence to the established criteria and to
ensure that on a continuing basis such standards are enforced and maintained.
Management's objective in establishing lending and investment standards
is to manage the risk of loss and provide for income generation through pricing
policies. To effectuate this policy, Cornerstone makes commercial real estate
and other loans with one year or less fixed maturity.
The loan portfolio is regularly reviewed and management determines the
amount of loans to be charged-off. In addition, such factors as Cornerstone's
previous loan loss experience, prevailing and anticipated economic conditions,
industry concentrations and the overall quality of the loan portfolio are
considered. While management uses available information to recognize losses on
loans and real estate owned, future additions to the allowance may be necessary
based on changes in economic conditions. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the allowances for losses on loans and real estate owned. Such agencies may
require Cornerstone to recognize additions to the allowances based on their
judgments about information available at the time of their examinations. In
addition, any loan or portion thereof which is classified as a "loss" by
regulatory examiners is charged-off.
The reserve for loan losses is increased by provisions charged to
operating expense. The reserve is reduced by charging off loans or portions of
loans at the time they are deemed by management to be uncollectible and
increased when loans previously charged off are recovered. The resulting reserve
for loan losses is viewed by management as a single, unallocated reserve
available for all loans and, in management's opinion, is adequate to provide for
reasonably foreseeable potential loan losses. Rules and formulas relative to the
adequacy of the reserve, although useful as guidelines to management, are not
rigidly applied. The reserve for loan losses was $915,000 at year end, or 1.49%
of
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11
loans outstanding. The following table presents data related to Cornerstone's
reserve for loan losses for the years ended December 31, 1997 and 1996.
December 31, 1997 December 31, 1996
----------------- -----------------
(In thousands)
Beginning balance............................... $497 $307
Provision for loan losses....................... 434 201
Net charge-offs................................. (16) (11)
---- ----
Ending balance................................ $915 $497
==== ====
The following table sets forth information regarding loans which are
past due 90 days or more and certain other information as of the dates
indicated:
December 31, 1997 December 31, 1996
----------------- -----------------
(Dollars in thousands)
Nonaccrual loans .................................................... $ -- $ --
Restructured loans .................................................. -- --
Loans past due 90 days or more to principal or interest payments..... 144 13
Nonperforming loans as a percentage of net loans before allowance 0.02% 0.05%
for loan losses .....................................................
Allowance for loan losses as a percentage of nonperforming loans..... 6354.2% 2276.92%
ITEM 2. PROPERTIES
Cornerstone has its principal offices in its main office building at
5319 Highway 153, Chattanooga, Tennessee, which is owned and occupied by
Cornerstone Community Bank. Cornerstone operates branches at 4154 Ringgold Road,
and 610 Georgia Avenue, Chattanooga, Tennessee. It also leases the space in
which it operates two branches in Foodmax Supermarkets. These two branches each
are comprised of approximately 450 square feet in each supermarket and are
leased pursuant to lease agreements entered into in August and November 1992 for
initial five year terms. Each lease provides two five year extensions. The
leases have been renewed for the first renewal period. The Georgia Avenue branch
contains 1800 square feet and is leased pursuant to a lease agreement which
provides for an initial term of three years with two three-year renewal
options.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which Cornerstone or
the Bank is a party or of which any of their properties are subject; nor are
there material proceedings known to the Cornerstone to be contemplated by any
governmental authority; nor are there material proceedings known to Cornerstone,
pending or contemplated, in which any director, officer or affiliate or any
principal security holder of Cornerstone, or any associate of any of the
foregoing, is a party or has an interest adverse to Cornerstone or the Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
- 11 -
12
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Cornerstone Common Stock is not listed, traded or quoted on any
securities exchange or in the over-the-counter market, and no dealer makes a
market in the Common Stock, although isolated transactions between individuals
occur from time to time. To Cornerstone management's knowledge, the most recent
transaction with respect to Cornerstone Common Stock was $15.00 per share.
There were approximately 475 holders of record of the Common Stock as
of March 31, 1998.
Cornerstone currently intends to retain its earnings, if any, for use
in the business and does not anticipate paying any cash dividends in the
foreseeable future. The board of directors cannot predict when such dividends,
if any, will ever be made. The payment of dividends, if any, shall at all times
be subject to the payment of Cornerstone's expenses, the maintenance of
reasonable working capital and risk reserves, and minimum capitalization
requirements for state banks. As a condition of its approval to begin
operations, the Bank is restricted by the Department of Financial Institutions
of the State of Tennessee from paying dividends until after February 1999
without the prior written consent of the Commissioner of the Department.
ITEM 6. SELECTED FINANCIAL DATA
See Item 14.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The following should be read in conjunction with the information and
tables which follow. For a discussion of liquidity and the impact of inflation,
see "Capital Resources/Liquidity" below.
The 1997 and 1996 statistical disclosures of Cornerstone under Guide 3
represent historical financial information presented on a pro forma basis as if
the merger of The Bank of East Ridge and Cornerstone Community Bank occurred as
of January 1, 1996. Guide 3 financial information presented on the pro forma
basis provides comparable data that is reasonable and meaningful to the combined
banking operations that began on the merger date of October 15, 1997.
SUMMARY
Net income for 1997 was $224,000, a 273% increase from Cornerstone's
net income of $60,000 in 1996. Net income per common share for 1997 was 189%
higher than in 1996. Pretax income for 1997 increased $368,000 from 1998 pretax
income of $0.
The increase in net income from 1996 to 1997 is primarily due to a 34%
decrease in the noninterest operating expenses and a decrease in the total loan
loss provision for the year. The increase was also due in part to an increase in
interest-earning assets of $18.85 million offset somewhat by a 39 basis point
decrease in the net interest margin.
FINANCIAL CONDITION
Earning Assets. Average earning assets in 1997 increased $14.7 million
or 22% over 1996 primarily due to an increase in average loans outstanding and
an increase in the average investment securities portfolio. The loan growth was
primarily funded by a significant increase in time deposits.
- 12 -
13
Loan Portfolio. Cornerstone's average loans for 1997 were $50.1
million, an increase of 56% over $32 million in average loans for 1996. Loan
growth for 1997 was primarily funded through increased deposit growth. Real
estate loans increased by $14 million or 49% and commercial loans increased by
$5 million or 86% over 1996. The increase in ending balances from 1996 to 1997
was consistent with the increase in average balances.
Investment Portfolio. Cornerstone's investment securities portfolio
increased by 8% or $1.3 million from 1996 to 1997. Cornerstone maintains an
investment strategy of seeking portfolio yields within acceptable risk levels,
as well as providing liquidity. Cornerstone maintains two classifications of
investment securities. "Held to Maturity" and "Available for Sale." The
"Available for Sale" securities are carried at fair market value, whereas the
"Held to Maturity" securities are carried at book value. At year end 1997,
unrealized gains in the "Available for Sale" portfolio amounted to $42,000.
Deposits. Cornerstone's average deposits increased $21.9 million or 44%
from 1996 to 1997. From year end 1996 to year end 1997, total deposits increased
$18.5 million or 29%. The largest portion of growth during 1997 was an $11.7
million, or 31% increase in time deposits. This is due to Cornerstone's strategy
of increasing time deposits by offering competitive rates to customers. From
1996 to 1997 interest-bearing transaction deposits increased $3.6 million or 39%
and savings deposits increased $502,000 or 5%.
Capital Resources. Stockholders' equity increased $3.0 million or 50%
to $9.0 million as of December 31, 1997, compared with $6.0 million at the end
of 1996. This increase was primarily due to warrants being exercised by
shareholders.
BALANCE SHEET MANAGEMENT
Liquidity Management. Liquidity is the ability of a company to convert
assets into cash without significant loss and to raise funds by increasing
liabilities. Liquidity management involves having the ability to meet day-to-day
cash flow requirements of its customers, whether they are depositors wishing to
withdraw funds or borrowers requiring funds to meet their credit needs.
The primary function of asset/liability management is not only to
assure adequate liquidity in order for Cornerstone to meet the needs of its
customer based, but to maintain an appropriate balance between
interest-sensitive assets and interest-sensitive liabilities so that Cornerstone
can profitably deploy its assets. Both assets and liabilities are considered
sources of liquidity funding and both are, therefore, monitored on a daily
basis.
The asset portion of the balance sheet provides liquidity primarily
through loan repayments and maturity of investment securities. Additional
sources of liquidity are the investment in federal funds sold and prepayments
from the mortgage-backed securities from the investment portfolio.
The liability portion of the balance sheet provides liquidity through
various interest-bearing and noninterest-bearing deposit accounts. At year end,
Cornerstone had approximately $2.0 million of federal funds lines available.
RESULTS OF OPERATIONS -- YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED
DECEMBER 31, 1996
Net Interest Income. Net interest income is the principal component of
a financial institution's income stream and represents the spread between
interest and fee income generated from earning assets and the interest expense
paid on deposits. The following discussion is on a fully taxable equivalent
basis.
Net interest income for 1997 decreased $214,000 or 9% over 1996. The
decrease in the net interest income from 1996 to 1997 is primarily due to the
increase in interest-earning deposits and a decrease in the net interest margin.
Interest income decreased $50,000 or 1% in 1997 from 1996. Interest
income produced by the loan portfolio decreased $89,000 or 3% in 1997 from 1996.
Interest income on investment securities increased $39,000 or 5% from 1996 to
1997. The increase in investment income is due to an increase in the average
investment securities portfolio during 1997.
- 13 -
14
Total interest expense increased $163,000 or 8% in 1997 from 1996. The
interest expense increase from 1996 to 1997 is primarily due to the increase in
average time deposits.
The trend in net income is commonly evaluated in terms of average rates
using the net interest margin and the interest rate spread. The net interest
margin, or the net yield on earning assets, is computed by dividing fully
taxable equivalent net interest income by average-earning assets. This ratio
represents the difference between the average yield on average-earning assets
and the average rate paid for all funds used to support those earning assets.
The net interest margin decreased 39 basis points in 1997 to 4.80%. The net cost
of funds, defined as interest expense divided by average-earning assets,
decreased 96 basis points from 3.89% in 1996 to 2.92% in 1997. The yield on
earning assets increased 22 basis points to 9.30% in 1997 from 9.08% in 1996.
The interest rate spread measures the difference between the average
yield on earning assets and the average rate paid on interest-bearing sources of
funds. The interest rate spread eliminates the impact of noninterest-bearing
funds and gives a direct perspective on the effect of market interest rate
movements. During recent years, the net interest margins and interest rate
spreads have been under intense pressure to maintain historical levels, due in
part to tax laws that discouraged investment in tax-exempt securities and
intense competition for funds with non-bank institutions. As a result of changes
in the asset and liability mix during 1997, the interest rate spread decreased
53 basis points from 1996 to 1997.
Allowance for Loan Losses. The allowance for possible loan losses
represents management's assessment of the risks associated with extending credit
and its evaluation of the quality of the loan portfolio. Management analyzes the
loan portfolio to determine the adequacy of the allowance for possible loan
losses and the appropriate provisions required to maintain a level considered
adequate to absorb anticipated loan losses. Management believes that the
$915,000 for December 1997 in the allowance for possible loan losses account was
sufficient to absorb known risks in the portfolio. No assurance can be given,
however, that adverse economic circumstances will not result in increased losses
in the loan portfolio and require greater provisions for possible loan losses in
the future.
Nonperforming Assets. Nonperforming assets include nonperforming loans
and foreclosed real estate held for sale. Nonperforming loans include loans
classified as nonaccrual or renegotiated. Cornerstone's policy is to place a
loan on nonaccrual status when it is contractually past due 90 days or more as
to payment of principal or interest. At the time a loan is placed on nonaccrual
status, interest previously accrued but not collected may be reversed and
charged against current earnings. Recognition of any interest after a loan has
been placed on nonaccrual is accounted for on a cash basis.
As of December 31, 1997, Cornerstone had $144,000 of nonperforming assets.
Noninterest Income. Noninterest income consists of revenues generated
from a broad range of financial services and activities including fee-based
services and profits and commissions earned through credit life insurance sales
and other activities. In addition, gains or losses realized from the sale of
investment portfolio securities are included in noninterest income. Total
noninterest income decreased by $274,000 or 55% from 1996 to 1997. Fee income
from service charges on deposit accounts decreased $158,000 or 45% in 1997
accounting for a larger portion of the total noninterest income decrease for the
year.
Noninterest Expense. Noninterest expense for 1997 decreased by $892,000
or 34% from 1996. Salaries and employee benefits decreased by $511,000 for 36%
from 1996 for a total of $928,000. This decrease was due to a reduction in staff
in 1997. Occupancy expense increased by $16,000 or 13% in 1997 which is
attributed to the additional expense of adding the Fountain Square location at
610 Georgia Avenue in 1997. All other noninterest expense decreased $397,000 or
47% in 1997, primarily the result of Cornerstone's organization costs of
$377,000 being a one-time occurrence in 1996.
CAPITAL RESOURCES/LIQUIDITY
Liquidity. Of primary importance to depositors, creditors and
regulators is the ability to have readily available funds sufficient to repay
fully maturing liabilities. Cornerstone's liquidity, represented by cash and
cash due from banks, is a result of its operating, investing and financing
activities. In order to insure funds are available at all times, Cornerstone
devotes resources to projecting on a monthly basis the amount of funds which
will be required and maintains relationships with a diversified customer base so
funds are accessible. Liquidity requirements can also be met through
- 14 -
15
short-term borrowings or the disposition of short-term assets which are
generally matched to correspond to the maturity of liabilities.
Although Cornerstone has no formal liquidity policy, in the opinion of
management, its liquidity levels are considered adequate. Cornerstone is not
subject to any specific regulatory liquidity requirements imposed by regulatory
orders. Cornerstone is subject to general FDIC guidelines which do not require a
minimum level of liquidity. Management believes its liquidity ratios meet or
exceed these guidelines. Management does not know of any trends or demands which
are reasonably likely to result in liquidity increasing or decreasing in any
material manner.
The following table sets forth liquidity ratios for the periods
indicated:
December 31, 1997 December 31, 1996
----------------- -----------------
Average loans to average deposits....... 69.48% 3.31%
Impact of Inflation and Changing Prices. The financial statements and
related financial data presented herein have been prepared in accordance with
generally accepted accounting principles which require the measurement of
financial position and operating results in terms of historical dollars without
considering the changes in the relative purchasing power of money over time and
due to inflation. The impact of inflation on operations of Cornerstone is
reflected in increased operating costs. Unlike most industrial companies,
virtually all of the assets and liabilities of Cornerstone are monetary in
nature. As a result, interest rates may have a more significant impact on
Cornerstone's performance than the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or in the same
magnitude as the price of goods and services.
CAPITAL ADEQUACY
Capital adequacy refers to the level of capital required to sustain
asset growth over time and to absorb losses. The objective of Cornerstone's
management is to maintain a level of capitalization that is sufficient to take
advantage of profitable growth opportunities while meeting regulatory
requirements. This is achieved by improving profitability through effectively
allocating resources to more profitable businesses, improving asset quality,
strengthening service quality, and streamlining costs. The primary measures used
by management to monitor the results of these efforts are the ratios of average
equity to average assets, average tangible equity to average tangible assets,
and average equity to net loans.
The FDIC has adopted capital guidelines governing the activities of
banks. These guidelines require the maintenance of an amount of capital based on
risk-adjusted assets so that categories of assets with potentially higher credit
risk will require more capital backing than assets with lower risk. In addition,
banks are required to maintain capital to support, on a risk-adjusted basis,
certain off-balance sheet activities such as loan commitments. The capital
guidelines classify capital into two tiers, referred to as Tier I and Tier II.
Under risk-based capital requirements, total capital consists of Tier I capital
which is generally common shareholders' equity less goodwill and Tier II capital
which is primarily a portion of the allowance for loan losses and certain
qualifying debt instruments. In determining risk-based capital requirements,
assets are assigned risk-weights of 0% to 100%, depending primarily on the
regulatory assigned levels of credit risk associated with such assets.
Off-balance sheet items are considered in the calculation of risk-adjusted
assets through conversion factors established by the regulators. The framework
for calculating risk-based capital requires banks to meet the regulatory
minimums of 4% Tier I and 8% total risk-based capital. In 1990 regulators added
a leverage computation to the capital requirements, comparing Tier I capital to
total average assets less goodwill.
- 15 -
16
December 31, 1997 December 31, 1996
----------------- -----------------
(Dollars in thousands)
CAPITAL:
Tier I capital:
Stockholders' equity ......................................... $ 6,764 $ 6,352
Less disallowed intangibles .................................. 43 (10)
------- --------
Total Tier I capital ................................ $ 6,721 $ 6,362
Tier II capital:
Qualifying debt .............................................. $ -- $ --
Qualifying allowance for loan losses ......................... $ 838 $ 497
Total Tier II capital ............................... $ 7,559 $ 6,859
Total capital ....................................... $ 7,559 $ 6,859
Risk-adjusted assets .................................................. $66,969 $ 46,406
Quarterly average assets .............................................. $82,957 $ 66,174
RATIOS:
Tier I capital to risk-adjusted assets ................................ 10.04% 13.71%
Tier II capital to risk-adjusted assets ............................... 11.29% 14.78%
Leverage -- Tier I capital to quarterly average assets less disallowed
intangibles ........................................................... 8.10% 9.61%
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") established five capital categories for banks. Under the regulations
defining these five capital categories, each bank is classified into one of the
five categories based on its level of risk-based capital as measured by Tier I
capital, total risk-based capital, and Tier I leverage ratios and its
supervisory ratings. The following table lists the five categories of capital
and each of the minimum requirements for the three risk-based capital ratios.
Total Risk-Based Tier I Risk-Based Leverage
Capital Ratio Capital Ratio Ratio
---------------- ----------------- ------------
Well-capitalized...................................... 10% or above 6% or above 5% or above
Adequately capitalized................................ 8% or above 4% or above 4% or above
Undercapitalized...................................... Less than 8% Less than 4% Less than 4%
Significantly undercapitalized........................ Less than 6% Less than 3% Less than 3%
Critically undercapitalized........................... -- -- 2% or less
On December 31, 1997, Cornerstone exceeded the regulatory minimums and
qualified as a well-capitalized institution under the regulations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements:
Cornerstone Bancshares, Inc. Page
----
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON
THE FINANCIAL STATEMENTS.............................................F-1
FINANCIAL STATEMENTS
Consolidated balance sheet...........................................F-2
Consolidated statement of income.....................................F-3
Consolidated statement of changes in stockholders' equity............F-4
Consolidated statement of cash flows.................................F-5
Notes to consolidated financial statements...........................F-6-17
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
ON ACCOMPANYING INFORMATION..........................................F-18
Consolidating balance sheet..........................................F-19
Consolidating statement of income....................................F-20
East Ridge Bancshares, Inc.
Report of Independent Accountants....................................F-21
Consolidated Balance Sheets..........................................F-22
Consolidated Statements of Income....................................F-23
Consolidated Statement of Stockholders' Equity.......................F-24
Consolidated Statement of Cash Flows.................................F-25
Notes to Consolidated Financial Statements...........................F-27
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
- 16 -
17
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Following is certain information regarding the directors and executive
officers of the Company.
DIRECTORS AND EXECUTIVE OFFICERS
The following table provides certain information regarding directors as
of March 31, 1998, all of whom have served as director since the inception of
Cornerstone in January 1996, and the executive officers of Cornerstone.
PRINCIPAL OCCUPATIONS
NAME AGE POSITIONS(1) FOR PREVIOUS 5 YEARS
- ---------------------------------- --------------------- ----------------------------- -----------------------------
Ramesh V. Amin.................... 51 Director President, American Plastics,
Inc.
Randy Brooks...................... 45 Director President, R. K. Haskew &
Company, Inc.
B. Kenneth Driver................. 62 Director President and Chief
Operating Officer, Fillauer,
Inc.
Karl Fillauer..................... 50 Director Chairman, Fillauer, Inc.
Timothy L. Hobbs.................. 39 President, Director Banker
Carolyn C. Johnson................ 54 Executive Vice President, Banker
Director
James H. Large.................... 54 Director President, Key James Brick &
Supply Company, Inc.
Lawrence D. Levine................ 68 Director President, Financial
Management Corp.
Russell W. Lloyd.................. 57 Director President, MPL Construction
Co., Inc.
Earl A. Marler, Jr................ 61 Chairman of the Board, Banker
Chief Executive Officer
Doyce G. Payne, M.D............... 47 Director Physician
Turner Smith...................... 57 Director Director, Southeast Energy
Services, Inc.
Billy O. Wiggins.................. 55 Director President, Checks, Inc.
Marsha Yessick................... 50 Director Owner, Yessick's Design
Center
- ----------
(1) All positions with Cornerstone are since inception (January 23, 1996).
No director of Cornerstone is related to any other director, except
Messrs. Brooks and Fillauer who are brothers-in-law. No director of Cornerstone
is a director or executive officer of another bank holding company, bank,
savings and loan association, or credit union. The following is a brief
description of the business experience of the executive officers of Cornerstone:
EARL A. MARLER, JR., Chairman of the Board and Chief Executive Officer,
was employed by J.C. Bradford & Company as an investment broker from 1992 until
1995. From 1978 to 1992, Mr. Marler was executive vice president of Inter
Federal Savings Bank, Chattanooga, Tennessee. His duties consisted primarily of
administrative responsibilities with emphasis on
- 17 -
18
strategic planning and marketing. From 1954 to 1978, Mr. Marler was employed by
First Tennessee Bank National Association, Chattanooga, Tennessee, where he
became senior vice president primarily responsible for the retail operations. He
received both a B.S. in Business Administration and a Masters of Business
Administration from the University of Tennessee, Chattanooga in 1958 and 1963,
respectively. He completed the Stonier Graduate School of Banking, Rutgers, New
Jersey and received Graduate Certificates in investments and commercial banking
from the American Institute of Banking.
TIMOTHY L. HOBBS, President, was vice president of financial planning
of First Federal Bank, FSB/AmSouth Bank, Chattanooga, Tennessee from July 1992
to September 1993. From 1981 to June 1992 he was employed by Inter Federal
Savings Bank, Chattanooga, Tennessee, where he served as vice president,
treasurer and chief financial officer. Mr. Hobbs received a B.S. in Accounting
from the University of Tennessee, Chattanooga, in 1980.
CAROLYN C. JOHNSON, Executive Vice President, was branch manager of the
Dallas Bay office of AmSouth Bank of Tennessee from February 1993 to April 1995.
She served as vice president and branch manager of First Federal Savings and
Loan, Chattanooga, Tennessee, Union Square branch, from April 1992 to February
1993. Ms. Johnson was employed by Inter Federal Savings Bank from January 1965
to April 1992.
TRANSACTIONS WITH MANAGEMENT
Cornerstone has and expects to have in the future banking and other
business transactions in the ordinary course of its banking business with
directors, officers, and 10% beneficial owners of Cornerstone and their
affiliates, including members of their families or corporations, partnerships,
or other organizations in which such officers or directors have a controlling
interest, on substantially the same terms (including price, or interest rates
and collateral) as those prevailing at the time for comparable transactions with
unrelated parties. Any such banking transactions will not involve more than the
normal risk of collectibility nor present other unfavorable features to
Cornerstone.
THE CORNERSTONE BOARD AND ITS COMMITTEES
Directors are elected annually and each director holds office until his
successor is elected and qualified. Committees of the Board and their members
include Nominating Committee (Messrs. Fillauer, Hobbs, Levine, Marler and
Payne), Directors' Loan Committee (Messrs. Amin, Brooks, Hobbs, Large, Marler,
Lloyd and Ms. Johnson) Asset/Liability Committee (Messrs. Driver, Fillauer,
Hobbs, Marler, Payne and Wiggins) and Audit Committee (Messrs. Levine, Lloyd,
Payne, Smith, and Ms. Yessick).
No director of Cornerstone is a director or executive officer of
another bank holding company, bank, savings and loan association, or credit
union.
During the last fiscal year, the Board of Directors of Cornerstone held
one meeting subsequent to October 1997. The Directors of Cornerstone also serve
as directors of the Bank. The Board of Directors of the Bank held twelve (12)
meetings in 1997. All but one director attended the meeting held by Cornerstone
subsequent to October 1997. The Directors received no compensation as directors
of Cornerstone.
- 18 -
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ITEM 11. EXECUTIVE COMPENSATION.
EXECUTIVE COMPENSATION
No executive officer of Cornerstone received cash compensation in
excess of $100,000 for the years ending December 31, 1997 and 1996. The Summary
Compensation Table provides information for the years indicated about the Chief
Executive Officer ("CEO")
Summary Compensation Table
Annual Compensation
----------------------------
(a) (b) (c) (d)
Name and Principal Position Year Salary ($) Bonus ($)
--------------------------- ---- ---------- ---------
Earl A. Marler, Jr., CEO 1997 $67,500 $3,375
1996 $65,000(1) $ 0
- ----------
(1) Annualized.
COMPENSATION OF DIRECTORS
During 1997, no director received any compensation for serving as a
member of the Cornerstone Board.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
OWNERSHIP OF CORNERSTONE COMMON STOCK
As of December 31, 1997, Cornerstone's records indicated the following
number of shares were beneficially owned by (i) each person who owns
beneficially 5% or more of the Cornerstone Common Stock, (ii) each person who is
a director or a named executive officer of Cornerstone and (iii) all directors
and executive officers as a group.
Amount and Nature
Name of of Beneficial Ownership Percent
Beneficial Owner (Number of Shares)(2) of Class(1)
---------------- --------------------- -----------
(i) David E. Young 62,093 7.10%
(ii) Ramesh V. Amin................................ 30,000 4.52%
Randy Brooks.................................. 16,556 3.00%
B. Kenneth Driver............................. 15,186 2.85%
Karl Fillauer................................. 15,000 2.83%
Timothy L. Hobbs ............................. 20,050 3.40%
Carolyn C. Johnson ........................... 20,050 3.40%
James H. Large................................ 24,980 3.41%
Lawrence D. Levine............................ 7,500 1.98%
Russell W. Lloyd.............................. 20,000 2.84%
Earl A. Marler, Jr............................ 30,178 4.54%
Doyce G. Payne, M.D........................... 20,500 3.45%
Turner Smith.................................. 10,000 2.26%
Billy O. Wiggins.............................. 26,000 3.52%
Marsha Yessick................................ 8,000 1.48%
- 19 -
20
(iii) Directors and executive officers as a group
(14 persons).................................. 264,000 38.59%
- ----------
(1) Based on 874,954 shares outstanding as of December 31, 1997.
(2) Excludes shares subject to options exercisable within 60 days after the
Record Date held by the following persons: Amin (10,000); Brooks
(10,000); Driver (10,000); Fillauer (10,000); Hobbs (10,000); Johnson
(10,000); Large (5,000); Levine (10,000); Lloyd (5,000); Marler
(10,000); Payne (10,000); Smith (10,000); Wiggins (5,000); and Yessick
(5,000); and Directors and executive officers as a group (120,000).
Such shares are deemed to be outstanding for the purpose of computing
the percentage of outstanding shares owned by such person, but are not
deemed to be outstanding for the purpose of computing the percentage
owned by any other person.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Cornerstone expects to have in the future banking and other business
transactions in the ordinary course of its banking business with directors,
officers, and 10% beneficial owners of Cornerstone and their affiliates,
including members of their families, or corporations, partnerships, or other
organizations in which such officers or directors have a controlling interest,
on substantially the same terms (including price, or interest rates and
collateral) as those prevailing at the time for comparable transactions with
unrelated parties. Any such banking transactions will not involve more than the
normal risk of collectibility nor present other unfavorable features to
Cornerstone or the Bank.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
(1) Exhibits
Exhibit Number Description
- -------------- -----------
3.1 Articles of Incorporation of Cornerstone Bancshares, Inc., as amended*
3.2 Bylaws of Cornerstone Bancshares, Inc.*
27 Financial Data Schedule (For SEC use only).
* Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-4, Registration No. 333-26699.
(2) Financial Statements
See Item 8 above.
(3) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended December 31,
1997.
- 20 -
21
Report of Independent Certified Public Accountants
on the Financial Statements
To the Stockholders and
Board of Directors
Cornerstone Bancshares, Inc.
Chattanooga, Tennessee
We have audited the accompanying consolidated balance sheet of
Cornerstone Bancshares, Inc. and subsidiary as of December 31, 1997, and the
related consolidated statements of income, changes in stockholders' equity, and
cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Cornerstone
Bancshares, Inc. and subsidiary as of December 31, 1997, and the results of
their operations and their cash flows for the year then ended in conformity with
generally accepted accounting principles.
Hazlett, Lewis & Bieter, PLLC
Chattanooga, Tennessee
March 25, 1998
F-1
22
CORNERSTONE BANCSHARES, INC.
CONSOLIDATED BALANCE SHEET
December 31, 1997
- --------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 6,173,892
Federal funds sold 1,130,000
Securities available for sale (Note 2) 7,544,579
Securities held to maturity (Note 2) 10,779,662
Loans, net of allowance for loan losses (Note 3) 60,589,987
Bank premises and equipment (Note 4) 2,444,219
Accrued interest receivable 584,446
Excess cost over fair value of net assets acquired 2,362,580
Other assets 1,093,520
------------
Total assets $ 92,702,885
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand deposits $ 9,272,695
NOW accounts 13,009,450
Savings deposits and money market accounts 9,879,431
Time deposits (Note 5) 49,688,229
------------
Total deposits 81,849,805
Accrued interest payable 325,551
Other liabilities 600,647
Note payable (Note 7) 855,000
------------
Total liabilities 83,631,003
------------
Stockholders' equity (Notes 7, 12, 13 and 14):
Preferred stock; no par value; 2,000,000 shares
authorized; no shares issued -
Common stock, $1.00 par value; 2,000,000 shares
authorized; 874,954 shares issued 874,954
Additional paid-in capital 8,444,238
Undivided profits (deficit) (290,027)
Net unrealized gain on securities available
for sale, net of tax 42,717
------------
Total stockholders' equity 9,071,882
------------
Total liabilities and stockholders' equity $ 92,702,885
============
The Notes to Financial Statements are an integral part of this statement.
F-2
23
CORNERSTONE BANCSHARES, INC.
CONSOLIDATED STATEMENT OF INCOME (Note 14)
Year Ended December 31, 1997
- -------------------------------------------------------------------------------
INTEREST INCOME
Loans $ 3,408,638
Securities 886,300
------------
Total interest income 4,294,938
INTEREST EXPENSE 2,153,457
------------
Net interest income 2,141,481
Provision for loan losses (Note 3) 273,277
------------
Net interest income after provision for loan losses 1,868,204
------------
NONINTEREST INCOME
Service charges 197,414
Other noninterest income 24,957
------------
Total noninterest income 222,371
------------
NONINTEREST EXPENSES
Salaries and employee benefits 928,270
Net occupancy and equipment expense 108,614
Other operating expenses 685,257
------------
Total noninterest expenses 1,722,141
------------
Income before income tax expense 368,434
Income tax expense (Note 6) 144,334
------------
Net income $ 224,100
============
The Notes to Financial Statements are an integral part of this statement.
F-3
24
CORNERSTONE BANCSHARES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
Net
Unrealized
Gain
Additional Undivided on Securities
Common Paid-in Profits Available
Total Stock Capital (Deficit) for Sale
----------- ----------- ----------- ----------- -------------
BALANCE, December 31, 1996 $ 3,047,276 $ 1,100,200 $ 34,500 $ 1,903,145 $ 9,431
Bank combination (Note 14) 4,232,940 (356,934) 6,961,166 (2,417,272) 45,980
Issuance of common stock (Note 12) 1,580,260 131,688 1,448,572 - -
Net income 224,100 - - 224,100 -
Net change in unrealized
gain on securities available
for sale (12,694) - - - (12,694)
----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 1997 $ 9,071,882 $ 874,954 $ 8,444,238 $ (290,027) $ 42,717
=========== =========== =========== =========== ===========
The Notes to Financial Statements are an integral part of this statement.
F-4
25
CORNERSTONE BANCSHARES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended December 31, 1997
- --------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 224,100
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 108,251
Provision for loan losses 273,277
Deferred income taxes (38,314)
Net amortization of premium on securities
Changes in other operating assets and liabilities, excluding
effects of bank combination:
Accrued interest receivable (162,195)
Accrued interest payable 125,432
Other (828,860)
-----------
Net cash used in operating activities (267,995)
-----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of securities held to maturity (6,347,646)
Proceeds from security transactions:
Securities available for sale 1,449,797
Securities held to maturity 2,187,693
Principal collected on securities available for sale 1,167,416
Principal collected on securities held to maturity 1,987,693
Net increase in loans (20,136,327)
Purchase of bank premises and equipment (332,638)
Proceeds from borrowings on line of credit 500,000
Payments related to bank combination (4,287,368)
Cash and cash equivalents acquired in bank combination 5,050,906
------------
Net cash used in investing activities (18,710,474)
-----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 19,889,783
Issuance of common stock 1,580,260
------------
Net cash provided by financing activities 21,470,043
------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,491,574
CASH AND CASH EQUIVALENTS, beginning of period 4,812,318
------------
CASH AND CASH EQUIVALENTS, end of period $ 7,303,892
============
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION
Cash paid during the period for interest $ 2,028,025
Cash paid during the period for taxes 199,859
============
The Notes to Financial Statements are an integral part of this statement.
F-5
26
CORNERSTONE BANCSHARES, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- -------------------------------------------------------------------------------
Note 1. Summary of Significant Accounting Policies
The accounting and reporting policies of Cornerstone Bancshares, Inc.
(Company) conform with generally accepted accounting principles and
practices within the banking industry. The policies that materially
affect financial position and results of operations are summarized as
follows:
Nature of operations:
The Company is a bank-holding company which owns all of the outstanding
common stock of Cornerstone Community Bank (the Bank). The Bank
provides a variety of financial services through 5 locations in
Chattanooga, Tennessee. The Bank's primary deposit products are demand
deposits, savings accounts, and certificates of deposit. Its primary
lending products are commercial loans, real estate loans, and
installment loans.
Principles of consolidation:
The consolidated financial statements include the accounts of the
Company and its subsidiary. All material intercompany accounts and
transactions have been eliminated in consolidation.
Excess cost over book value of investment in subsidiary:
The excess cost over book value of investment in subsidiary represents
the excess of the cost of the investment over the underlying net assets
of the subsidiary bank at the date of acquisition. Certain amounts have
been allocated to specific tangible assets in the accompanying
financial statements. The excess cost over book value of investment in
subsidiary is being amortized over 25 years using the straight-line
method.
Use of estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles 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 revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
A material estimate that is particularly susceptible to significant
change relates to the determination of the allowance for losses on
loans. In connection with the determination of the allowance for losses
on loans, management obtains independent appraisals for significant
properties.
F-6
27
CORNERSTONE COMMUNITY BANK
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- -------------------------------------------------------------------------------
Note 1. Summary of Significant Accounting Policies (continued)
Use of estimates: (continued)
While management uses available information to recognize losses on
loans, future additions to the allowance may be necessary based on
changes in local economic conditions. In addition, regulatory agencies,
as an integral part of their examination process, periodically review
the Bank's allowance for losses on loans. Such agencies may require the
Bank to recognize additions to the allowance based on their judgments
about information available to them at the time of their examination.
Because of these factors, it is reasonably possible that the allowance
for losses on loans may change materially in the near term.
Cash and cash equivalents:
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, and federal funds sold.
Securities held to maturity:
The Bank has the positive intent and ability to hold to maturity or
return of principal all securities held to maturity. Securities held to
maturity are reported at cost, adjusted for premiums and discounts that
are recognized in interest income over the period to maturity.
Securities available for sale:
Securities available for sale consist of bonds, notes, debentures and
certain equity securities not classified as securities held to
maturity. Unrealized holding gains and losses, net of tax, on
securities available for sale are reported as a net amount in a
separate component of stockholders' equity until realized. Gains and
losses on the sale of securities available for sale are determined
using the specific-identification method. Premiums and discounts are
recognized in interest income over the period to maturity.
Loans:
Loans are stated at unpaid principal balances less the allowance for
loan losses.
Loans are placed on nonaccrual when a loan is specifically determined
to be impaired or when, in the opinion of management, there is an
indication that the borrower may be unable to meet payments as they
become due. Any unpaid interest previously accrued on those loans is
reversed from income. Interest income generally is not recognized on
specific impaired loans unless the likelihood of further loss is
remote. Interest payments received on such loans are applied as a
reduction of the loan principal balance. Interest income on other
nonaccrual loans is recognized only to the extent of interest payments
received.
F-7
28
CORNERSTONE COMMUNITY BANK
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- -------------------------------------------------------------------------------
Note 1. Summary of Significant Accounting Policies (continued)
Loans: (continued)
The allowance for loan losses is maintained at a level which, in
management's judgment, is adequate to absorb credit losses inherent in
the loan portfolio. The amount of the allowance is based on
management's evaluation of the collectibility of the loan portfolio,
including the nature of the portfolio, credit concentrations, trends in
historical loss experience, specific impaired loans, and economic
conditions. Allowances for impaired loans are generally determined
based on collateral values or the present value of estimated cash
flows. The allowance is increased by a provision for loan losses, which
is charged to expense, and reduced by charge-offs, net of recoveries.
Bank premises and equipment:
Bank premises and equipment are stated at cost, less accumulated
depreciation. Depreciation is computed using the straight-line
depreciation method and accelerated depreciation methods for both
financial statement purposes and income tax purposes. Bank premises are
depreciated over 30 years; and furniture, fixtures and equipment are
depreciated over 5 to 12 years.
Additions and major renewals and betterments are capitalized and
depreciated over their estimated useful lives. Repairs, maintenance,
and minor renewals are charged to operating expense as incurred. When
property is replaced or otherwise disposed of, the cost of such assets
and the related accumulated depreciation are removed from the accounts.
The gain or loss, if any, is recorded in the statement of income.
Deferred income taxes:
Deferred tax assets and liabilities are reflected at currently enacted
income tax rates applicable to the period in which the deferred tax
assets or liabilities are expected to be realized or settled. As
changes in tax laws or rates are enacted, deferred tax assets and
liabilities are adjusted through the provision for income taxes.
Note 2. Securities
Securities have been classified in the balance sheet according to
managemen's intent as either securities held to maturity or securities
available for sale.
F-8
29
CORNERSTONE BANCSHARES, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- -------------------------------------------------------------------------------
Note 2. Securities (continued)
The amortized cost and approximate market value of securities at
December 31, 1997 is as follows:
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------ ------------ ------------- -------------
Securities available for sale:
U.S. Government
securities $ 1,447,896 $ 3,745 $ (250) $ 1,451,391
Securities of U.S
Government agencies
and corporations 1,815,419 11,840 (31) 1,827,228
Mortgage-backed
securities 4,212,366 53,924 (330) 4,265,960
------------ ------------ ------------ ------------
$ 7,475,681 $ 69,509 $ (611) $ 7,544,579
============ ============ ============ ============
Securities held to maturity:
U.S. Government
securities $ 3,173,685 $ 4,337 $ (3,719) $ 3,174,303
Mortgage-backed
securities 7,605,977 64,843 (9,511) 7,661,309
------------ ------------ ------------ ------------
$ 10,779,662 $ 69,180 $ (13,230) $ 10,835,612
============ ============ ============ ============
The amortized cost and estimated market value of securities at December 31,
1997, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
Securities Available for Sale Securities Held to Maturity
----------------------------- ---------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
----------- ------------ ----------- -----------
Due in one year or less $ 1,565,199 $ 1,566,526 $ 849,685 $ 847,660
Due from one year to
five years 1,916,434 1,930,032 2,609,734 2,615,875
Due from five years to
ten years 602,171 607,986 524,692 527,955
Due after ten years 3,391,877 3,440,035 6,795,551 6,844,122
----------- ----------- ----------- -----------
$ 7,475,681 $ 7,544,579 $10,779,662 $10,835,612
=========== =========== =========== ===========
F-9
30
CORNERSTONE COMMUNITY BANK
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- -------------------------------------------------------------------------------
Note 2. Securities (continued)
Proceeds from the sale of securities were $2,572,054 in 1997. The Bank
realized gross gains of $103,394 on these sales in 1997. Securities
with a book value of approximately $5,697,218 at December 31, 1997 were
pledged to secure various deposits.
Note 3. Loans and Allowance for Loan Losses
A summary of transactions in the allowance for loan losses for the
periods ended December 31, 1997 is as follows: 1997
Balance, beginning of year $ 201,422
Provision charged to operating expense 273,277
Balance acquired in business combination 456,960
Recoveries for loans charged off -
Loans charged off 16,654
---------
Balance, end of year $ 915,005
=========
At December 31, 1997, the Bank's loans consist of the following (in
thousands):
Real estate loans $ 42,842
Commercial and industrial loans 12,069
Loans to individuals for household,
family, and other consumer expenditures 6,241
Other 353
---------
Total loans 61,505
Less - Allowance for loan losses (915)
---------
Net loans $ 60,590
=========
The Bank's only significant concentration of credit at December 31,
1997, occurred in real estate loans which totaled approximately
$42,716,000. While real estate loans accounted for 71 percent of total
loans, these loans were primarily residential development and
construction loans, residential mortgage loans, commercial loans
secured by commercial properties, and consumer loans. Substantially all
real estate loans are secured by properties located in Tennessee.
F-10
31
CORNERSTONE COMMUNITY BANK
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- -------------------------------------------------------------------------------
Note 3. Loans and Allowance for Loan Losses (continued)
In the normal course of business, the Bank makes loans to directors and
executive officers of the Bank on substantially the same terms,
including interest rates and collateral, as those prevailing at the
time for comparable transactions with other borrowers. Loans to
directors, executive officers and principal shareholders were
approximately $2,000,000 at December 31, 1997.
At December 31, 1997, there were no loans specifically classified as
impaired by management.
Note 4. Bank Premises and Equipment
A summary of Bank premises and equipment at December 31, 1997 is
summarized as follows:
Land $ 463,278
Buildings and improvements 1,517,986
Furniture, fixtures and equipment 1,282,946
-----------
3,264,210
Accumulated depreciation (819,991)
-----------
$ 2,444,219
===========
The charge to operating expense for depreciation was $108,251 in 1997.
Certain Bank facilities and equipment are leased under various
operating leases. Rental expense was 28,324 in 1997.
Future minimum rental commitments under noncanelable leases are:
1998 $ 76,320
1999 56,420
2000 52,440
2001 52,440
2002 39,560
---------
$ 277,180
=========
Note 5. Time Deposits
The aggregate amount of jumbo CDs, each with a minimum denomination of
$100,000, totaled $12,951,340 at December 31, 1997.
F-11
32
CORNERSTONE COMMUNITY BANK
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- -------------------------------------------------------------------------------
Note 5. Time Deposits (continued)
At December 31, 1997, the scheduled maturities of time deposits are as
follows:
1998 $27,939,601
1999 17,471,715
2000 2,898,255
2001 660,875
Thereafter 717,783
-----------
Total $49,688,289
===========
Note 6. Income Taxes
Income tax expense in the statement of income for the year ended
December 31, 1997 consists of the following:
Current tax expense $ 182,648
Deferred income taxes related to:
Provision for loan losses (24,700)
Net operating loss carryforward (8,000)
Other (5,614)
---------
Income tax expense $ 144,334
=========
The income tax benefit is different from the expected tax benefit
computed by multiplying loss before income tax benefit by the statutory
federal income tax rates. The reasons for this difference are as
follows: 1997
Expected tax at statutory rates $ 140,005
Increase resulting from tax effect of
non-deductible expenses $ 4,329
---------
Income tax expense $ 144,334
=========
The Bank has a net operating loss carryforward for tax purposes of
$29,000 at December 31, 1997 which can be carried forward and used to
offset future taxable income. This net operating loss carryforward will
expire in year 2011.
As of December 31, 1997, deferred tax assets recognized for deductible
temporary differences totaled $516,000.
F-12
33
CORNERSTONE COMMUNITY BANK
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
Note 7. Note Payable
The note payable represents borrowings under a $1,000,000 revolving
line of credit with First Tennessee Bank and is collateralized by all
of the outstanding stock of the Bank. Interest is payable annually
based on First Tennessee Bank's base commercial rate, which was 8.5% at
December 31, 1997. The line of credit agreement expires on April 1,
1998, but may be converted to a 10-year term note. The Company intends
to renew the revolving line of credit at maturity.
Note 8. Employee Benefit Plan
The Bank has a 401(k) employee benefit plan covering substantially all
employees who have completed at least one year of service and met
minimum age requirements. The amount of employer contribution is
computed annually under a defined formula based primarily on the
employees' salary. The maximum employer required contribution to the
plan is 3% of the employees' annual salary. Any additional contribution
to the plan is determined at the discretion of the Board of Directors.
Total contributions to the plan were $7,491 in 1997.
Note 9. Financial Instruments With Off-Balance-Sheet Risk
The Bank is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of
its customers. These financial instruments include various commitments
to extend credit and standby letters of credit. These instruments
expose the Bank to varying degrees of credit and interest rate risk in
excess of the amount recognized in the accompanying balance sheet. To
manage this risk, the Bank uses the same management policies and
procedures for financial instruments with off-balance-sheet risk as it
does for financial instruments whose risk is reflected on the balance
sheet.
The credit risk of all financial instruments varies based on many
factors, including the value of collateral held and other security
arrangements. To mitigate credit risk, the Bank generally determines
the need for specific covenant, guarantee, and collateral requirements
on a case-by-case basis, depending on the customer's creditworthiness.
The amount and type of collateral held to reduce credit risk vary, but
may include real estate, machinery, equipment, inventory, and accounts
receivable as well as cash on deposit, stocks, bonds, and other
marketable securities that are generally held in the Bank's possession.
This collateral is valued and inspected to ensure both its existence
and adequacy. The Bank requests additional collateral when appropriate.
At December 31, 1997, commitments under standby letters of credit and
undisbursed loan commitments aggregated $6,952,584. The Bank's credit
exposure for these financial instruments is represented by their
contractual amounts. The Bank does not anticipate any material losses
as a result of the commitments under standby letters of credit and
undisbursed loan commitments.
F-13
34
CORNERSTONE COMMUNITY BANK
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- --------------------------------------------------------------------------------
Note 10. Contingencies
The Bank is involved in certain claims arising from normal business
activities. Management believes that those claims are without merit or
that the ultimate liability, if any, resulting from them will not
materiallay affect the Bank's position.
Note 11. Liquidity and Capital Resources
The Company's primary source of funds with which to pay principal and
interest on its indebtedness is the receipt of dividends from its
subsidiary bank. Banking regulators limit the amount of dividends that
the Bank may pay without prior approval of the Bank's regulatory
agency. As discussed in Note 13, the Bank cannot pay dividends until
March 1999.
Note 12. Stock Options and Warrants
The Company has a stock option plan under which members of the Board of
Directors have been granted options to purchase a total of 140,000
shares of the Company's common stock. The option grant price was $10.00
per share which was the estimated fair value of the stock at the June
30, 1996 grant date. The options expire ten years from the date of
grant and were fully vested at the grant date. There have been no
exercises of grants since the original grant date. At December 31,
1997, the remaining contractual life of outstanding options was 8.5
years, respectively.
The Company also has a stock option plan under which officers and
employees can be granted options to purchase shares of the Company's
common stock. There have been no shares allocated under this plan.
A stock warrant was issued with each of the 590,130 original shares of
the Company's common stock which entitles each stockholder to purchase
an additional share of the Company's common stock at a specified price.
At December 31, 1997, warrants for the purchase of 458,442 shares were
outstanding. The exercise price is $12.00 per share until February 1999
and $15.00 per share thereafter. If not exercised, such warrants will
expire five years after issuance. In connection with the acquisition of
the Bank of East Ridge 131,688 warrants were exercised in 1997.
F-14
35
CORNERSTONE COMMUNITY BANK
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- -------------------------------------------------------------------------------
Note 13. Regulatory Matters
The Bank is subject to various regulatory capital requirements
administered by the Tennessee Department of Financial Institutions and
the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possibly additional
discretionary--actions by regulators that, if undertaken, could have a
direct material effect on the Bank's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of the Bank's assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are
also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in
the regulations) to risk-weighted assets (as defined), and of Tier I
capital (as defined) to average assets (as defined). Management
believes, as of December 31, 1997, that the Bank meets all capital
adequacy requirements to which it is subject.
As of December 31, 1997, the most recent notification from the
Commissioner of the Tennessee Department of Financial Institutions
categorized the Bank as well capitalized under the regulatory framework
for prompt corrective action. There are no conditions or events since
that notification that management believes have changed the
institution's prompt corrective action category.
The Bank's actual capital amounts and ratios are also presented in the
table. Dollar amounts are presented in thousands.
For Capital
Actual Adequacy Purposes
----------------- --------------------
Amount Ratio Amount Ratio
------ ----- ------ -----
At December 31, 1997
Total capital
(to risk-weighted assets $7,637 11.4% $5,358 8.0%
Tier I capital
(to risk-weighted assets) 6,721 10.0% 2,679 4.0%
Tier I capital
(to average assets) 6,721 8.1% 6,533 8.0%
F-15
36
CORNERSTONE COMMUNITY BANK
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- -------------------------------------------------------------------------------
Note 13. Regulatory Matters (continued)
As a condition of the bank combination described in Note 12, the Bank
must maintain certain financial conditions as follows:
- The Bank cannot pay dividends through February 1999.
- The Bank must maintain a Tier I capital to assets ratio of no
less than 8% through February 1999.
- The Bank must maintain a minimum allowance for loan losses
ratio of 1.25% through February 1999.
The Bank was in compliance with all of these financial conditions at
December 31, 1997.
Note 14. Bank Combination
On October 15, 1997, the Company completed a combination of the Bank of
East Ridge (East Ridge) with Cornerstone Community Bank (Cornerstone).
The surviving bank operates as Cornerstone Community Bank. All of
East Ridge's outstanding common stock owned by the Company was redeemed
in the combination and all of the Company's outstanding common stock of
record on October 15, 1997 was retired with stockholders of that date
receiving cash and/or newly issued shares of common stock of the
Company. The combination resulted in a change in control of ownership
and management of the Company as the officers and directors of
Cornerstone Community Bank replaced all of the officers and directors
of the Company.
The purchase price totaled $6,125,000 and was comprised of $4,287,368
cash and 153,136 shares of newly issued common stock. The purchase
price exceeded the fair value of net assets acquired by approximately
$2,300,000, which is being amortized on the straight-line basis over 25
years. The combination has been accounted for as a purchase accounting
transaction and, accordingly, the operating results of East Ridge are
included in the accompanying financial statements from the date of
combination.
F-16
37
CORNERSTONE COMMUNITY BANK
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
- -------------------------------------------------------------------------------
Note 14. Bank Combination (continued)
The following unaudited pro forma consolidated results of operations
for the year ended December 31, 1997 assumes the Cornerstone and East
Ridge combination occurred as of January 1, 1997 (in thousands):
Interest income $7,012
Interest expense 3,387
------
Net interest income 3,625
Provision for loan losses 463
------
Net interest income after provision for loan losses 3,162
Non-interest income 579
Non-interest expense 3,375
------
Income before income taxes 366
Income taxes 97
------
Net income $ 269
======
F-17
38
Report of Independent Certified Public Accountants
on Accompanying Information
To the Stockholders and
Board of Directors
Cornerstone Bancshares, Inc.
Chattanooga, Tennessee
Our report on our audit of the basic financial statements of
Cornerstone Bancshares, Inc. and subsidiary for 1997 appears on page 1. That
audit was made for the purpose of forming an opinion on the consolidated
financial statements taken as a whole. The consolidating information shown on
pages 19 and 20 is presented for purposes of additional analysis of the
consolidated financial statements rather than to present the financial
position, results of operations, and cash flows of the individual companies.
The consolidating information has been subjected to the auditing procedures
applied in the audit of the consolidated financial statements and, in our
opinion, is fairly stated in all material respects in relation to the
consolidated financial statements taken as a whole.
Chattanooga, Tennessee
March 25, 1998
F-18
39
CORNERSTONE BANCSHARES, INC.
CONSOLIDATING BALANCE SHEET
December 31, 1997
- -------------------------------------------------------------------------------
Cornerstone
Cornerstone Bancshares,
ASSETS Bank Inc. Eliminations Consolidated
-------------- ------------ ------------ ------------
Cash and due from banks $ 6,173,892 $ 939,493 $ 939,493 $ 6,173,892
Federal funds sold 1,130,000 - - 1,130,000
Securities available for sale 7,544,579 - - 7,544,579
Securities held to maturity 10,740,324 39,338 - 10,779,662
Loans, net of allowance for loan losses 60,464,464 125,523 - 60,589,987
Bank premises and equipment 1,944,219 500,000 - 2,444,219
Accrued interest receivable 584,446 - - 584,446
Excess cost over fair value of assets acquired - 2,362,580 - 2,362,580
Other assets 1,385,718 - 292,198 1,093,520
Investment in subsidiary - 6,764,184 6,764,184 -
----------- ------------ ----------- ------------
Total assets $89,967,642 $ 10,731,118 $ 7,995,875 $ 92,702,885
=========== ============ =========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand deposits $ 9,712,188 $ - $ 439,493 $ 9,272,695
NOW accounts 13,009,450 - - 13,009,450
Savings deposits and money market accounts 9,879,431 - - 9,879,431
Time deposits 49,688,229 - - 49,688,229
----------- ------------ ----------- ------------
Total deposits 82,289,298 - 439,493 81,849,805
Accrued interest payable 325,551 - - 325,551
Other liabilities 588,609 804,236 792,198 600,647
Note payable - 855,000 - 855,000
----------- ------------ ----------- ------------
Total liabilities 83,203,458 1,659,236 1,231,691 83,631,003
Stockholders' equity:
Preferred stock; no par value; 2,000,000 shares
authorized; no shares issued - - - -
Common stock, $1.00 par value; 2,000,000 shares
authorized; 874,954 shares issued 590,130 874,954 590,130 874,954
Additional paid-in capital - 8,444,238 - 8,444,238
Surplus 6,287,054 - 6,287,054 -
Undivided profits (deficit) (155,717) (290,027) (155,717) (290,027)
Net unrealized gain on securities available
for sale, net of tax 42,717 42,717 42,717 42,717
----------- ------------ ----------- ------------
Total stockholders' equity 6,764,184 9,071,882 6,764,184 9,071,882
----------- ------------ ----------- ------------
Total liabilities and stockholders' equity $89,967,642 $ 10,731,118 $ 7,995,875 $ 92,702,885
=========== ============ =========== ============
F-19
40
CORNERSTONE BANCSHARES, INC.
CONSOLIDATING STATEMENT OF INCOME
Year Ended December 31, 1997
- -------------------------------------------------------------------------------
Cornerstone
Cornerstone Bancshares,
Bank Inc. Eliminations Consolidated
----------- ----------- ------------ ------------
INTEREST INCOME
Loans $3,408,638 $ - $ - $3,408,638
Securities 886,300 - - 886,300
---------- ---------- ------------ ----------
Total interest income 4,294,938 - - 4,294,938
INTEREST EXPENSE 2,141,419 12,038 - 2,153,457
---------- ---------- ------------ ----------
Net interest income 2,153,519 (12,038) - 2,141,481
Provision for loan losses 273,277 - - 273,277
---------- ---------- ------------ ----------
Net interest income after provision for loan losses 1,880,242 (12,038) - 1,868,204
---------- ---------- ------------ ----------
NONINTEREST INCOME
Service charges 197,414 - - 197,414
Other noninteresst income 24,957 - - 24,957
Gain (loss) on sale of securities 103,394 (103,394) - -
Equity in subsidiary's earnings - 358,410 358,410 -
---------- ---------- ------------ ----------
Total noninterest income 325,765 255,016 358,410 222,371
---------- ---------- ------------ ----------
NONINTEREST EXPENSES
Salaries and employee benefits 928,270 - - 928,270
Net occupancy and equipment expense 108,614 - - 108,614
Other operating expenses 666,379 18,878 - 685,257
---------- ---------- ------------ ----------
Total noninterest expenses 1,703,263 18,878 - 1,722,141
---------- ---------- ------------ ----------
Income before income tax benefit 502,744 236,138 358,410 368,434
Income tax expense 144,334 - - 144,334
---------- ---------- ------------ ----------
Net income $ 358,410 $ 224,100 $ 358,410 $ 224,100
========== ========== ============ ==========
The Notes to Financial Statements are an integral part of this statement.
F-20
41
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Stockholders
East Ridge Bancshares, Inc. and Subsidiary
East Ridge, Tennessee
We have audited the accompanying consolidated balance sheets of East Ridge
Bancshares, Inc. and subsidiary as of December 31, 1996 and 1995, and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the three years in the period ended December 31, 1996. These
consolidated financial statements are the responsibility of the company's
management. Our responsibility is to express an opinion on the consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of East Ridge
Bancshares, Inc. and subsidiary as of December 31, 1996 and 1995, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1996, in conformity with generally accepted
accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The accompanying
consolidating information is presented for purposes of additional analysis and
is not a required part of the basic consolidated financial statements. Such
information has been subjected to the auditing procedures applied in the audits
of the basic consolidated financial statements and, in our opinion, is fairly
stated in all material respects in relation to the basic consolidated financial
statements taken as a whole.
The corporation changed its method of accounting for debt securities during
1994.
Joseph Decosimo and Company
Chattanooga, Tennessee
February 10, 1997
F-21
42
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1995
1996 1995
ASSETS
Cash and Due from Banks $ 2,360,643 $ 2,249,472
Federal Funds Sold 4,315,000 575,000
----------- -----------
Total Cash and Cash Equivalents 6,675,643 2,824,472
Securities Available-for-Sale 5,299,037 7,014,683
Securities to be Held to Maturity 5,475,306 6,104,238
Loans - less allowance for loan losses of
$296,487 for 1996 and $306,997 for 1995 24,977,654 22,407,252
Bank Premises and Equipment, net 847,832 950,772
Interest Receivable 286,396 324,157
Other Assets 803,822 773,655
----------- -----------
TOTAL ASSETS $44,365,690 $40,399,229
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits -
Demand $ 4,983,065 $ 4,306,914
Interest-Bearing Demand 8,547,951 8,267,850
Savings 6,559,326 6,623,161
Certificates of Deposit of $100,000 or More 3,754,252 3,616,387
Certificates of Deposit Under $100,000 16,717,625 14,302,457
----------- -----------
Total Deposits 40,562,219 37,116,769
Other Liabilities 756,195 632,437
----------- -----------
Total Liabilities 41,318,414 37,749,206
----------- -----------
STOCKHOLDERS' EQUITY
Common Stock - $10 par value - 150,000 shares
authorized; 110,020 shares issued for 1996 and
112,000 shares issued for 1995 1,100,200 1,120,000
Paid-In Surplus 34,500 84,000
Retained Earnings 1,903,145 1,416,767
Unrealized Appreciation (Depreciation) on
Securities Available-for-Sale, net of tax
of $5,781 for 1996 and $(17,931) in 1995 9,431 29,256
----------- -----------
Total Stockholders' Equity 3,047,276 2,650,023
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $44,365,690 $40,399,229
=========== ===========
The accompanying notes are an integral part of the financial statements.
F-22
43
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1996, 1995 and 1994
1996 1995 1994
INTEREST INCOME
Loans $2,529,196 $2,361,102 $2,033,287
Investment Securities -
U.S. Treasury 133,902 106,748 75,152
U.S. Government Agencies 425,586 397,268 337,239
States and Political Subdivisions 155,187 71,563 4,551
Other 17,104 -- --
Income on Federal Funds Sold 67,565 104,596 29,900
---------- ---------- ----------
3,328,540 3,041,277 2,480,129
---------- ---------- ----------
INTEREST EXPENSE
Interest on Certificates of Deposit
of $100,000 or More 214,004 202,325 78,099
Interest on Other Deposits 1,294,923 1,167,519 835,586
Other 31,929 31,689 22,811
---------- ---------- ----------
1,540,856 1,401,533 936,496
---------- ---------- ----------
NET INTEREST INCOME BEFORE
PROVISION FOR LOAN LOSSES 1,787,684 1,639,744 1,543,633
Provision for Loan Losses 36,000 48,000 74,000
---------- ---------- ----------
NET INTEREST INCOME 1,751,684 1,591,744 1,469,633
---------- ---------- ----------
NONINTEREST INCOME
Service Charges on Deposit Accounts 323,677 340,389 344,051
Credit Life Commissions 10,260 6,034 6,394
Other 124,404 95,450 148,621
---------- ---------- ----------
458,341 441,873 499,066
---------- ---------- ----------
NONINTEREST EXPENSES
Salaries 795,670 761,432 763,920
Employee Benefits 135,706 140,057 151,043
Net Occupancy 79,228 97,219 94,983
Other 510,943 542,042 607,083
---------- ---------- ----------
1,521,547 1,540,750 1,617,029
---------- ---------- ----------
INCOME BEFORE PROVISION FOR
INCOME TAXES 688,478 492,867 351,670
Provision for Income Taxes 202,100 149,800 132,300
---------- ---------- ----------
NET INCOME $ 486,378 $ 343,067 $ 219,370
========== ========== ==========
COMMON STOCK DATA
Weighted Average Number of
Common Shares Outstanding 111,993 112,000 112,000
========== ========== ==========
Net Income Per Share $ 4.34 $ 3.06 $ 1.96
========== ========== ==========
The accompanying notes are an integral part of the financial statements.
F-23
44
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1996, 1995 and 1994
UNREALIZED
APPRECIATION
(DEPRECIATION)
ON SECURITIES
COMMON STOCK PAID-IN RETAINED AVAILABLE-
SHARES AMOUNT SURPLUS EARNINGS FOR-SALE
BALANCE - December 31, 1993 112,000 $ 1,120,000 $ 84,000 $ 854,330 $ -
Adjustment of Securities
to Market Value Upon
Adoption of Statement of
Financial Accounting
Standards No. 115 7,803
Net Changes in Unrealized
Appreciation on
Securities Available-
for-Sale ( 56,107)
Net Income 219,370
------- ----------- --------- ----------- ---------
BALANCE - December 31, 1994 112,000 1,120,000 84,000 1,073,700 ( 48,304)
Net Changes in Unrealized
Appreciation on Securities
Available-for-Sale 77,560
Net Income 343,067
------- ----------- --------- ----------- ---------
BALANCE - December 31, 1995 112,000 1,120,000 84,000 1,416,767 29,256
Retirement of Common Stock ( 1,980) ( 19,800) ( 49,500)
Net Changes in Unrealized
Appreciation on Securities
Available-for-Sale ( 19,825)
Net Income 486,378
------- ----------- --------- ----------- ---------
BALANCE - December 31, 1996 110,020 $ 1,100,200 $ 34,500 $ 1,903,145 $ 9,431
======= =========== ========= =========== =========
The accompanying notes are an integral part of the financial statements.
F-24
45
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1996, 1995 and 1994
1996 1995 1994
CASH FLOWS FROM OPERATING
ACTIVITIES
Interest Received $ 3,366,301 $ 2,964,086 $ 2,410,007
Noninterest Income Received 388,761 407,447 405,566
Interest Paid (1,479,462) (1,359,883) (908,268)
Cash Paid to Suppliers and Employees (1,429,366) (1,496,536) (1,451,387)
Income Taxes Paid (175,228) (251,363) (47,378)
----------- ----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 671,006 263,751 408,540
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from Sales, Calls and Maturities of
Available-for-Sale Securities 3,083,912 1,152,294 1,682,997
Purchase of Available-for-Sale Securities (1,386,535) (4,551,189) (548,750)
Proceeds from Calls and Maturities
of Held-to-Maturity Securities 1,715,964 1,001,420 662,759
Purchase of Held-to-Maturity Securities (1,051,162) (3,012,886) (2,427,911)
Net Increase in Loans (3,356,102) (931,519) (3,307,799)
Acquisition of Premises and Equipment (6,194) (94,564) (93,892)
Proceeds on Sale of Loan 794,682 -- 855,737
----------- ----------- -----------
NET CASH USED BY INVESTING ACTIVITIES (205,435) (6,436,444) (3,176,859)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net Increase in Deposits 3,445,450 6,441,091 985,504
Principal Payments on Long-Term Debt -- -- (324,000)
Proceeds from Issuance of Long-Term Debt -- -- 355,000
Retirement of Common Stock (59,850) -- --
----------- ----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 3,385,600 6,441,091 1,016,504
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS 3,851,171 268,398 (1,751,815)
CASH AND CASH EQUIVALENTS -
beginning of year 2,824,472 2,556,074 4,307,889
----------- ----------- -----------
CASH AND CASH EQUIVALENTS -
end of year $ 6,675,643 $ 2,824,472 $ 2,556,074
=========== =========== ===========
The accompanying notes are an integral part of the financial statements.
F-25
46
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1996, 1995 and 1994
1996 1995 1994
RECONCILIATION OF NET INCOME TO
NET CASH PROVIDED BY
OPERATING ACTIVITIES
Net Income $ 486,378 $ 343,067 $ 219,370
Depreciation 109,134 113,087 102,580
Amortization and Accretion (49,487) (38,434) (6,122)
Provision for Loan Losses 36,000 48,000 74,000
Gain on Investments (89) -- --
Gain on Sale of Loan (44,982) -- (58,893)
Deferred Income Taxes (1,000) (14,600) (34,125)
Deferred Compensation 16,879 15,303 13,495
Net Increase in Cash Surrender Value
of Insurance Policies (24,509) (34,426) (34,607)
Changes in Operating Assets and
Liabilities -
Decrease (Increase) in -
Interest Receivable 37,761 (77,191) (70,122)
Other Assets 7,492 246 (3,321)
Increase (Decrease) in -
Interest Payable 61,394 41,650 28,228
Other Liabilities 8,123 (45,988) 58,969
Income Taxes Payable 27,912 (86,963) 119,088
----------- ----------- -----------
NET CASH PROVIDED BY OPERATING
ACTIVITIES $ 671,006 $ 263,751 $ 408,540
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF
NONCASH INVESTING AND
FINANCING ACTIVITIES
Unrealized Appreciation (Depreciation)
on Available-for-Sale Securities,
net of deferred taxes $ (19,825) $ 77,560 $ (48,304)
Issuance of Promissory Note Upon
Purchase and Retirement of Common
Stock $ 9,450 $ - $ -
The accompanying notes are an integral part of the financial statements.
F-26
47
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies and practices of East Ridge Bancshares,
Inc. and subsidiary conform with generally accepted accounting principles and
general practice within the banking industry.
Descriptions of significant policies and practices are as follows:
DESCRIPTION OF BUSINESS - The corporation is a one-bank holding company
primarily conducting business in Hamilton County in Tennessee and the
surrounding areas through its subsidiary, The Bank of East Ridge.
CASH AND DUE FROM BANKS - The company maintains at various financial
institutions cash accounts which may exceed federally insured amounts at times.
CASH AND CASH EQUIVALENTS - For purposes of cash flows, the corporation
considers Federal Funds Sold and other cash items to be cash equivalents.
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the
accounts of the parent company and its wholly-owned subsidiary. All
intercompany accounts and transactions have been eliminated in consolidation.
INVESTMENT SECURITIES - Investment securities that the corporation has the
positive intent and ability to hold to maturity are classified as
held-to-maturity and are stated at cost adjusted for amortization of premiums
and accretion of discounts, which are recognized as adjustments to interest
income. Investment securities considered available-for-sale are adjusted for
unrealized holding gains and losses and recorded at fair value. The difference
in fair value and cost adjusted for amortization and accretion for securities
available-for-sale is shown as a separate component of stockholders' equity net
of income tax effects. Gains or losses on disposition are based on the net
proceeds and the adjusted carrying amount of the securities sold, using the
specific identification method.
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses is established
through a provision for loan losses charged to expenses. Loans are charged
against the allowance for loan losses when management believes the collection
of principal is unlikely. The allowance is determined by management based on
loan loss experience and evaluation of potential loss in the current loan
portfolio.
BANK PREMISES AND EQUIPMENT - Bank premises and equipment are stated at cost
less accumulated depreciation. Expenditures for repairs and maintenance are
charged to expense as incurred and additions and improvements that
significantly extend the lives of assets are capitalized. As assets are
retired or otherwise disposed of, cost and accumulated depreciation are removed
from the related accounts and any gain or loss is reflected in operations.
Depreciation is provided primarily using the straight-line method over the
estimated useful lives of the depreciable assets.
F-27
48
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
INTEREST INCOME ON LOANS - Interest on loans is accrued and credited to income
based on the principal amount outstanding. The accrual of interest on loans is
discounted when, in the opinion of management, there is an indication that the
borrower may be unable to meet payments as they become due. Upon such
discontinuance, all unpaid accrued interest is reversed.
INCOME TAXES - The parent and its wholly-owned subsidiary file consolidated
federal income tax returns.
Income taxes are computed based on the provisions of Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes." Deferred tax
assets and liabilities are recognized for the estimated future tax effects
attributed to temporary differences between book and tax bases of assets and
liabilities and for carryforward items. The measurement of current and
deferred tax assets and liabilities is based on enacted tax law. Deferred tax
assets are reduced, if necessary, by a valuation allowance for the amount of
tax benefits that may not be realized.
COMMON STOCK DATA - Earnings per share is computed by dividing the net income
for the period by the weighted average number of common and common equivalent
shares outstanding during the period.
ESTIMATES AND UNCERTAINTIES - The preparation of financial statements in
conformity with generally accepted accounting principles 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 revenues and expenses
during the reporting period. Actual results could differ from those estimates.
RECLASSIFICATIONS - Certain reclassifications have been made to prior years'
financial statements to conform with the current year presentation.
INVESTMENT SECURITIES
During 1994, the bank adopted Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity Securities." The
statement requires investment securities to be classified in three categories:
held-to-maturity, available-for-sale and trading. For securities to be
classified as held-to-maturity, the bank must demonstrate the positive intent
and ability to hold the securities to maturity. Trading securities, of which
the bank has none, are securities bought and held principally for the purpose
of selling them in the near future. Available-for-sale securities are those
securities not classified as held-to-maturity or trading.
The amortized cost and estimated market value of securities at December 31,
1996 and 1995, by contractual maturity, are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
Included in U.S. Government Agencies and other securities are certain
collateralized mortgage obligations with an amortized cost of $144,048
available-for-sale and $159,213 held-to-maturity for 1996 and $727,708
available-for-sale and $313,624 held-to-maturity for 1995 and an estimated
market value of $144,487 available-for-sale and $154,337 held-to-maturity for
1996 and $721,696 available-for-sale and $305,394 held-to-maturity for 1995.
F-28
49
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INVESTMENT SECURITIES - continued
DECEMBER 31, 1996
GROSS GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
AVAILABLE-FOR-SALE
U.S. Treasury -
Maturing within one year $ 598,798 $ 3,640 $ -- $ 602,438
Maturing after one but
within five years 1,237,900 3,123 2,101 1,238,922
---------- ------- ---------- ----------
1,836,698 6,763 2,101 1,841,360
---------- ------- ---------- ----------
U.S. Government Agencies -
Maturing within one year 234,446 900 168 235,178
Maturing after one but within
five years 1,240,210 4,030 2,567 1,241,673
Maturing after five but within
ten years 200,000 -- 1,859 198,141
Maturing after ten years 555,782 4,204 3,450 556,536
---------- ------- ---------- ----------
2,230,438 9,134 8,044 2,231,528
---------- ------- ---------- ----------
States and Political Subdivisions -
Maturing after ten years 937,210 14,563 374 951,399
---------- ------- ---------- ----------
Other -
Maturing after ten years 279,479 -- 4,729 274,750
---------- ------- ---------- ----------
Total Investment Securities
Available-for-Sale $5,283,825 $30,460 $ 15,248 $5,299,037
========== ======= ========== ==========
HELD-TO-MATURITY
U.S. Government Agencies -
Maturing after one but within
five years $2,106,754 $ 177 $ 20,614 $2,086,317
Maturing after ten years 1,461,628 10,465 14,991 1,457,102
---------- ------- ---------- ----------
3,568,382 10,642 35,605 3,543,419
---------- ------- ---------- ----------
States and Political Subdivisions -
Maturing after five but within
ten years 145,834 -- 500 145,334
Maturing after ten years 1,761,090 37,782 5,746 1,793,126
---------- ------- ---------- ----------
1,906,924 37,782 6,246 1,938,460
---------- ------- ---------- ----------
Total Investment Securities
Held-to-Maturity $5,475,306 $48,424 $ 41,851 $5,481,879
========== ======= ========== ==========
F-29
50
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INVESTMENT SECURITIES - continued
DECEMBER 31, 1995
GROSS GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
AVAILABLE-FOR-SALE
U.S. Treasury -
Maturing within one year $ 901,512 $ 663 $ 2,116 $ 900,059
Maturing after one but
within five years 1,491,877 19,243 -- 1,511,120
---------- ------- ---------- ----------
2,393,389 19,906 2,116 2,411,179
---------- ------- ---------- ----------
U.S. Government Agencies -
Maturing within one year 100,562 -- 790 99,772
Maturing after one but within
five years 1,915,485 10,444 758 1,925,171
Maturing after five but within
ten years 447,907 6,642 -- 454,549
Maturing after ten years 958,578 10,902 7,650 961,830
---------- ------- ---------- ----------
3,422,532 27,988 9,198 3,441,322
---------- ------- ---------- ----------
States and Political Subdivisions -
Maturing after ten years 872,260 12,722 -- 884,982
---------- ------- ---------- ----------
Other -
Maturing after ten years 279,315 -- 2,115 277,200
---------- ------- ---------- ----------
Total Investment Securities
Available-for-Sale $6,967,496 $60,616 $ 13,429 $7,014,683
========== ======= ========== ==========
HELD-TO-MATURITY
U.S. Government Agencies -
Maturing within one year $ 38,266 $ -- $ -- $ 38,266
Maturing after one but within
five years 1,644,391 -- 35,595 1,608,796
Maturing after five but within
ten years 1,594,653 9,447 876 1,603,224
Maturing after ten years 1,068,042 10,423 14,629 1,063,836
---------- ------- ---------- ----------
4,345,352 19,870 51,100 4,314,122
---------- ------- ---------- ----------
States and Political Subdivisions -
Maturing after ten years 1,758,886 42,758 6,108 1,795,536
---------- ------- ---------- ----------
Total Investment Securities
Held-to-Maturity $6,104,238 $62,628 $ 57,208 $6,109,658
========== ======= ========== ==========
Securities pledged to secure various public deposits and other balances have an
amortized cost of $1,634,493 and a market value of $1,625,624 as of December
31, 1996, and an amortized cost of $2,464,422 and a market value of $2,453,867
as of December 31, 1995.
F-30
51
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INVESTMENT SECURITIES - continued
Gross realized gains and gross realized losses on sales of available-for-sale
securities were $6,327 and $6,238, respectively, for 1996. No sales
transactions occurred during 1995 and 1994.
As permitted by the Financial Accounting Standards Board, the bank made a
one-time reclassification of certain securities prior to December 31, 1995.
Securities transferred from the held-to-maturity to the available-for-sale
classification had amortized costs of $1,383,392 and unrealized gains of
$12,171 as of the date of transfer.
LOANS
Major classifications of loans are as follows:
1996 1995
Real Estate Loans $ 16,607,000 $ 14,782,000
Commercial and Industrial Loans 4,329,000 3,602,000
Consumer Installment Loans 4,338,141 4,330,249
------------ ------------
25,274,141 22,714,249
Allowance for Loan Losses (296,487) (306,997)
------------ ------------
Net Loans $ 24,977,654 $ 22,407,252
============ ============
Transactions in the allowance for loan losses are summarized as follows:
1996 1995 1994
Allowance for Loan Losses -
beginning of year $ 306,997 $ 284,714 $ 192,636
Provision for Loan Losses 36,000 48,000 74,000
Loans Charged Off (58,458) (33,765) (25,587)
Recoveries 11,948 8,048 43,665
--------- --------- ---------
Allowance for Loan Losses - end of year $ 296,487 $ 306,997 $ 284,714
========= ========= =========
Because of uncertainties inherent in the estimation process, management's
estimate of credit losses inherent in the loan portfolio and the related
allowance may change in the near term. However, the amount of the change that
is reasonably possible cannot be estimated.
F-31
52
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
BANK PREMISES AND EQUIPMENT
Bank premises and equipment consist of the following:
1996 1995
Land and Improvements $ 182,712 $ 182,712
Buildings 447,447 447,447
Furniture and Equipment 828,851 822,658
Automobiles 36,590 36,590
----------- -----------
1,495,600 1,489,407
Accumulated Depreciation (647,768) (538,635)
----------- -----------
$ 847,832 $ 950,772
=========== ===========
OTHER LIABILITIES
On March 29, 1994, the corporation entered into a $1,000,000 revolving credit
agreement with a financial institution. The corporation may borrow up to the
maximum principal amount of this line and it is collateralized by all of the
outstanding stock of The Bank of East Ridge. Interest equal to the financial
institution's base commercial rate is payable annually. The line of credit
agreement expires April 1, 1997, but may be converted to a 10-year term note if
the corporation is in compliance with the terms of the agreement.
An outstanding balance of $355,000 is included in other liabilities as of
December 31, 1996 and 1995.
The loan agreement related to the revolving credit line contains various
restrictive covenants which include minimum capital and performance ratios of
the subsidiary, restrictions on fixed asset additions, other indebtedness and
dividend payments. The corporation was not in compliance with certain
covenants as of December 31, 1996; however, the financial institution has
waived its rights under the agreement arising from those violations.
The corporation entered into a promissory note on December 31, 1996, in the
amount of $9,450. Interest will be paid at a rate of 6% per annum with the
note due June 30, 1997.
RELATED PARTIES
Certain directors of the corporation and companies in which they were principal
owners were loan customers of the bank during 1996 and 1995. Such loans are
made in the ordinary course of business at normal credit terms, including
interest rate and collateralization. The total of such loans amounted to
$168,058 as of December 31, 1996, and $122,958 as of December 31, 1995. During
1996, $151,072 of these loans were made and repayments totaled $105,972.
F-32
53
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INCOME TAXES
The provision for income taxes consists of the following:
1996 1995 1994
Current Provision $ 203,100 $ 164,400 $ 166,500
Deferred Provision (1,000) (14,600) (34,200)
--------- --------- ---------
$ 202,100 $ 149,800 $ 132,300
========= ========= =========
Reconciliation of the provision for income taxes to statutory rates is as
follows:
1996 1995 1994
Federal Income Tax at Statutory Rate $ 236,900 $ 167,600 $ 116,800
Decreases Resulting From -
Tax Exempt Interest (45,900) (24,300) (1,700)
Life Insurance (9,300) (13,100) (13,200)
Other (4,600) (3,900) (2,500)
Increases Resulting From -
State Income Taxes, net of federal income tax benefit 24,300 17,200 10,800
Other 700 6,300 22,100
--------- --------- ---------
$ 202,100 $ 149,800 $ 132,300
========= ========= =========
The following is a summary of the significant components of the corporation's
deferred tax assets and liabilities:
1996 1995
DEFERRED TAX ASSETS
Loan Loss Reserve $102,743 $106,947
Other 16,570 13,195
-------- --------
119,313 120,142
-------- --------
DEFERRED TAX LIABILITIES
Property and Equipment 79,736 81,565
Securities Available-for-Sale 5,781 17,931
-------- --------
85,517 99,496
-------- --------
NET DEFERRED TAX ASSETS $ 33,796 $ 20,646
======== ========
F-33
54
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
401(k) PLAN
The bank's 401(k) Plan (the plan) covers employees meeting certain age and
service requirements. Participants of the plan may make elective contributions
up to the maximum percentage allowable through a salary reduction plan. The
bank may make matching contributions equal to a discretionary percentage, to be
determined by the bank, of the participants' salary reductions. Contributions
to the plan were $7,020 for 1996, $6,554 for 1995 and $6,817 for 1994.
DEFERRED COMPENSATION PLAN
The bank's salary continuation and survivor income plans cover certain officers
and directors. The plans were funded by single premium contributions. The
present value of future benefit payments is accrued annually. The following
summarizes this information:
1996 1995
Current Value of Life Insurance Policies -
beginning of year $ 706,198 $ 671,772
Amortization of Surrender Charges (10,395) --
Mortality Cost (6,582) (6,106)
Policy Income 41,486 40,532
--------- ---------
Current Value of Life Insurance Policies -
end of year $ 730,707 $ 706,198
========= =========
Present Value of Future Benefit Payments $ 55,064 $ 38,185
========= =========
OPERATING LEASE
The bank leases certain real estate under noncancelable operating leases. The
leases include an option to renew during 1997 for a five year term. Future
minimum lease payments under the leases as of December 31, 1996, are as
follows:
YEAR ENDING
December 31, 1997 $ 36,400
Rental expense totaled $46,444 for 1996, $67,037 for 1995 and $102,290 for
1994.
F-34
55
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS
OF CREDIT RISK
The bank is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and standby letters
of credit. Those instruments involve, to varying degrees, elements of credit
risk in excess of the amount recognized in the balance sheet. The contract or
notional amounts of those instruments express the extent of involvement the
bank has in particular classes of financial instruments.
East Ridge Bancshares, Inc. and subsidiary's exposure to credit loss from
nonperformance by the other party to the financial instruments for commitments
to extend credit and standby letters of credit is represented by the
contractual amount of those instruments. The bank uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments.
The bank generally requires collateral or other security to support financial
instruments with off-balance-sheet credit risk.
CONTRACT OR NOTIONAL AMOUNT
DECEMBER 31,
1996 1995
Financial Instruments Whose
Contracts Represent Credit Risk -
Commitments to Extend Credit $5,702,298 $6,578,245
Standby Letters of Credit 366,025 152,300
---------- ----------
$6,068,323 $6,730,545
========== ==========
Commitments to extend credit are agreements to lend to customers. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of fees. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future liquidity requirements. The amount drawn on the total
commitments is $3,475,990 as of December 31, 1996, and $3,805,750 as of
December 31, 1995. The bank evaluates each customer's credit worthiness on a
case-by-case basis. The amount of collateral obtained if deemed necessary by
the bank on extension of credit is based on management's credit assessment of
the counterparty. Collateral held varies but may include certificates of
deposit, assignment of life insurance policies, automobiles and real estate.
The amount collateralized as of December 31, 1996, was 69% and as of December
31, 1995, was 60%.
Standby letters of credit are conditional commitments issued by the bank
guaranteeing performance by a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. The bank holds personal guarantees
as collateral supporting those commitments. The extent of collateral held for
those commitments varies.
F-35
56
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT
RISK - continued
The bank's loan portfolio is diversified with regard to customers, industries
and types of collateral although most of the bank's business is in Hamilton
County and 66% of its 1996 loans and 65% of its 1995 loans are real estate
related. Occasionally, loans to a customer or to a group of related entities
may constitute a concentration of credit risk. As of December 31, 1996, three
such concentrations existed consisting of loans to three customers representing
17%, 17% and 16% of the bank's total capital. As of December 31, 1995, four
such concentrations existed consisting of loans to four customers representing
17%, 16%, 16% and 15% of the bank's total capital.
The bank's aggregate amount of cash value life insurance policies as a percent
of the bank's total capital was 22% as of December 31, 1996, and 24% as of
December 31, 1995.
SUPPLEMENTAL FINANCIAL DATA
Components of other noninterest income and noninterest expenses in excess of 1%
of income not disclosed elsewhere for the respective periods are as follows:
1996 1995 1994
Noninterest Income -
Earnings on Cash Surrender Value
of Life Insurance Policies $41,486 $40,532 $40,277
Noninterest Expense -
Furniture and Equipment Repair $62,381 $54,780 $62,137
Printing Supplies $53,979 $62,011 $59,951
FDIC Insurance Premiums $ -- $36,101 $ 7,323
Telephone $ -- $31,480 $35,662
REGULATORY MATTERS
The corporation and bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - and possibly additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the corporation's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the corporation and bank must meet specific capital guidelines that involve
quantitative measures of the corporation and bank's assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The corporation and bank's capital amounts and classification are
also subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
F-36
57
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
REGULATORY MATTERS - continued
Quantitative measures established by regulation to ensure capital adequacy
require the corporation and bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and Tier I capital (as
defined) to average assets (as defined). Management believes, as of December
31, 1996, that the corporation and bank meet all capital adequacy requirements
to which they are subject.
As of December 31, 1996, the most recent notifications from the Federal Deposit
Insurance Corporation categorized the bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, the corporation and bank must maintain minimum total risk-based,
Tier I risk-based and Tier I leverage ratios as set forth in the table. There
are no conditions or events since that notification that management believes
have changed the corporation and bank's category.
The corporation's and bank's actual capital amounts and ratios are also
presented in the table.
TO BE WELL
FOR CAPITAL CAPITALIZED UNDER PROMPT
ACTUAL ADEQUACY PURPOSES CORRECTIVE ACTION PROVISIONS
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
DECEMBER 31, 1996
TOTAL CAPITAL
(TO RISK WEIGHTED ASSETS)
East Ridge Bancshares,
Inc. and Subsidiary $ 3,334,332 12.0% $ 2,230,000 >8.0% $ 2,787,500 >10.0%
- -
The Bank of East
Ridge $ 3,634,000 13.0% $ 2,230,240 >8.0% $ 2,787,800 >10.0%
- -
TIER I CAPITAL
(TO RISK WEIGHTED ASSETS)
East Ridge Bancshares,
Inc. and Subsidiary $ 3,037,845 10.9% $ 1,115,000 >4.0% $ 1,672,500 >6.0%
- -
The Bank of East
Ridge $ 3,337,236 12.0% $ 1,115,120 >4.0% $ 1,672,680 >6.0%
- -
TIER I CAPITAL
(TO AVERAGE ASSETS)
East Ridge Bancshares,
Inc. and Subsidiary $ 3,037,845 7.0% $ 1,727,600 >4.0% $ 2,159,500 >5.0%
- -
The Bank of East
Ridge $ 3,337,236 7.7% $ 1,727,720 >4.0% $ 2,159,650 >5.0%
- -
F-37
58
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
REGULATORY MATTERS - continued
TO BE WELL
FOR CAPITAL CAPITALIZED UNDER PROMPT
ACTUAL ADEQUACY PURPOSES CORRECTIVE ACTION PROVISIONS
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
DECEMBER 31, 1995
TOTAL CAPITAL
(TO RISK WEIGHTED ASSETS)
East Ridge Bancshares,
Inc. and Subsidiary $ 2,927,764 11.6% $ 2,026,270 >8.0% $ 2,532,838 >10.0%
- -
The Bank of East
Ridge $ 3,288,935 13.0% $ 2,026,510 >8.0% $ 2,533,138 >10.0%
- -
TIER I CAPITAL
(TO RISK WEIGHTED ASSETS)
East Ridge Bancshares,
Inc. and Subsidiary $ 2,620,767 10.3% $ 1,013,135 >4.0% $ 1,519,703 >6.0%
- -
The Bank of East
Ridge $ 2,981,938 11.8% $ 1,013,255 >4.0% $ 1,519,883 >6.0%
- -
TIER I CAPITAL
(TO AVERAGE ASSETS)
East Ridge Bancshares,
Inc. and Subsidiary $ 2,620,767 6.6% $ 1,577,280 >4.0% $ 1,971,600 >5.0%
- -
The Bank of East
Ridge $ 2,981,938 7.6% $ 1,577,400 >4.0% $ 1,971,750 >5.0%
- -
COMMITMENTS
On November 8, 1996, the corporation and bank entered into an agreement with
officers and full-time employees of the bank to pay severance benefits if
officers and employees are involuntarily terminated within the two-year period
after the closing date of a change in control as defined in the agreement. The
maximum severance benefits payable could be approximately $299,000.
SUBSEQUENT EVENT
Subsequent to year end, The Bank of East Ridge entered into discussions to
merge with another bank. The surviving corporation will be The Bank of East
Ridge. At the closing, The Bank of East Ridge will amend and restate its
charter to change its name and change its authorized shares and par value.
F-38
59
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
Condensed financial statements of East Ridge Bancshares, Inc. are summarized as
follows:
CONDENSED BALANCE SHEETS
1996 1995
ASSETS
Cash $ 102,862 $ 7,687
Investment in Subsidiary 3,346,667 3,011,194
Receivable from Subsidiary 42,544 36,134
---------- ----------
TOTAL ASSETS $3,492,073 $3,055,015
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Other Liabilities $ 444,797 $ 404,992
---------- ----------
STOCKHOLDERS' EQUITY
Common Stock - $10 par value - 150,000 shares authorized;
110,020 shares issued 1,100,200 1,120,000
Paid-In Surplus 34,500 84,000
Retained Earnings 1,903,145 1,416,767
Unrealized Appreciation on Securities
Available-for-Sale 9,431 29,256
---------- ----------
Total Stockholders' Equity 3,047,276 2,650,023
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $3,492,073 $3,055,015
========== ==========
F-39
60
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED PARENT COMPANY FINANCIAL STATEMENTS - continued
CONDENSED STATEMENTS OF INCOME AND RETAINED EARNINGS
1996 1995 1994
INCOME
Dividend $ 150,000 $ 15,000 $ 86,000
Other Income 329 1,972 562
----------- ----------- -----------
150,329 16,972 86,562
----------- ----------- -----------
EXPENSES
Interest 31,929 31,689 22,811
Other Expense 120 -- 556
----------- ----------- -----------
32,049 31,689 23,367
----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAX
BENEFIT AND EQUITY IN
UNDISTRIBUTED INCOME OF
SUBSIDIARY 118,280 (14,717) 63,195
Income Tax Benefit (12,800) (10,300) (10,500)
----------- ----------- -----------
INCOME (LOSS) BEFORE EQUITY IN
UNDISTRIBUTED INCOME OF SUBSIDIARY 131,080 (4,417) 73,695
Equity in Undistributed Income of Subsidiary 355,298 347,484 145,675
----------- ----------- -----------
NET INCOME 486,378 343,067 219,370
RETAINED EARNINGS - beginning of year 1,416,767 1,073,700 854,330
----------- ----------- -----------
RETAINED EARNINGS - end of year $ 1,903,145 $ 1,416,767 $ 1,073,700
=========== =========== ===========
F-40
61
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED PARENT COMPANY FINANCIAL STATEMENTS - continued
CONDENSED STATEMENTS OF CASH FLOWS
1996 1995 1994
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 486,378 $ 343,067 $ 219,370
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating
Activities -
Equity in Earnings of Subsidiary (505,298) (362,484) (231,675)
Dividends Received from Subsidiary 150,000 15,000 86,000
Changes in Operating Assets and Liabilities -
Decrease (Increase) in -
Receivable from Subsidiary (6,410) 89,151 (125,285)
Taxes Receivable -- -- 14,390
Increase (Decrease) in -
Payable to Subsidiary -- -- (5,386)
Interest Payable 511 3,424 5,599
Other Payables 1,932 103 548
Taxes Payable 27,912 (86,963) 104,698
--------- --------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 155,025 1,298 68,259
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Additional Capitalization of Subsidiary -- -- (100,000)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of Debt -- -- (324,000)
Proceeds from Issuance of Long-Term Debt -- -- 355,000
Retirement of Common Stock (59,850) -- --
--------- --------- ---------
NET CASH PROVIDED (USED) BY
FINANCING ACTIVITIES (59,850) -- 31,000
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH 95,175 1,298 (741)
CASH - beginning of year 7,687 6,389 7,130
--------- --------- ---------
CASH - end of year $ 102,862 $ 7,687 $ 6,389
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION
Interest Paid $ 31,418 $ 28,265 $ 17,212
Income Tax Received $ (34,302) $ (12,488) $ (1,606)
Changes in Unrealized Appreciation
(Depreciation) on Available-for-Sale
Securities, net of deferred taxes $ (19,825) $ 77,560 $ (48,304)
Issuance of Promissory Note Upon
Purchase and Retirement of Common Stock $ 9,450 $ -- $ --
F-41
62
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATING BALANCE SHEET
DECEMBER 31, 1996
THE BANK OF EAST RIDGE
EAST RIDGE BANCSHARES, INC. CONSOLIDATED
(i)
ASSETS
Cash and Due from Banks $ 2,360,643 $ 102,862 $ 2,360,643
Federal Funds Sold 4,315,000 -- 4,315,000
----------- ---------- -----------
Total Cash and Cash Equivalents 6,675,643 102,862 6,675,643
Securities Available-for-Sale 5,299,037 -- 5,299,037
Securities to be Held to Maturity 5,475,306 -- 5,475,306
Loans - less allowance for
loan losses of $296,487 24,977,654 -- 24,977,654
Bank Premises and Equipment, net 847,832 -- 847,832
Interest Receivable 286,396 -- 286,396
Investment in Subsidiary -- 3,346,667 --
Other Assets 806,822 42,544 803,822
----------- ---------- -----------
TOTAL ASSETS $44,368,690 $3,492,073 $44,365,690
=========== ========== ===========
(i) Certain items have been eliminated in consolidation.
F-42
63
THE BANK OF EAST RIDGE
EAST RIDGE BANCSHARES, INC. CONSOLIDATED
(i)
LIABILITIES AND
STOCKHOLDERS' EQUITY
LIABILITIES
Deposits -
Demand $ 4,983,065 $ -- $ 4,983,065
Interest-Bearing Demand 8,650,813 -- 8,547,951
Savings 6,559,326 -- 6,559,326
Certificates of Deposit of
$100,000 or More 3,754,252 -- 3,754,252
Certificates of Deposit
Under $100,000 16,717,625 -- 16,717,625
----------- ---------- -----------
Total Deposits 40,665,081 -- 40,562,219
Other Liabilities 356,942 444,797 756,195
----------- ---------- -----------
Total Liabilities 41,022,023 444,797 41,318,414
----------- ---------- -----------
STOCKHOLDERS' EQUITY
Common Stock - $10 par value -
150,000 shares authorized;
110,020 shares issued -- 1,100,200 1,100,200
Common Stock - $40 par value -
20,000 shares authorized;
17,142 shares issued 685,680 -- --
Paid-In Surplus 1,114,320 34,500 34,500
Retained Earnings 1,537,236 1,903,145 1,903,145
Unrealized Appreciation on Securities
Available-for-Sale 9,431 9,431 9,431
----------- ---------- -----------
Total Stockholders' Equity 3,346,667 3,047,276 3,047,276
----------- ---------- -----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $44,368,690 $3,492,073 $44,365,690
=========== ========== ===========
F-43
64
EAST RIDGE BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATING SCHEDULE OF INCOME
Year Ended December 31, 1996
THE BANK OF EAST RIDGE
EAST RIDGE BANCSHARES, INC. CONSOLIDATED
(i)
INTEREST INCOME
Loans $ 2,529,196 $ -- $ 2,529,196
Investment Securities -
U.S. Treasury 133,902 -- 133,902
U.S. Government Agencies 425,586 -- 425,586
States and Political Subdivisions 155,187 -- 155,187
Other 17,104 -- 17,104
Income on Federal Funds Sold 67,565 -- 67,565
Other -- 329 --
----------- ----------- -----------
3,328,540 329 3,328,540
----------- ----------- -----------
INTEREST EXPENSE
Interest on Certificates of Deposit
of $100,000 or More 214,004 -- 214,004
Interest on Other Deposits 1,295,252 -- 1,294,923
Other -- 31,929 31,929
----------- ----------- -----------
1,509,256 31,929 1,540,856
----------- ----------- -----------
NET INTEREST INCOME (EXPENSE)
BEFORE PROVISION FOR LOAN LOSSES 1,819,284 (31,600) 1,787,684
Provision for Loan Losses 36,000 -- 36,000
----------- ----------- -----------
NET INTEREST INCOME (LOSS) 1,783,284 (31,600) 1,751,684
----------- ----------- -----------
NONINTEREST INCOME
Service Charges on Deposit Accounts 323,677 -- 323,677
Credit Life Commissions 10,260 -- 10,260
Dividend from Subsidiary -- 150,000 --
Equity in Earnings of Subsidiary -- 355,298 --
Other 124,404 -- 124,404
----------- ----------- -----------
458,341 505,298 458,341
----------- ----------- -----------
NONINTEREST EXPENSES
Salaries 795,670 -- 795,670
Employee Benefits 135,706 -- 135,706
Net Occupancy 79,228 -- 79,228
Other 510,823 120 510,943
----------- ----------- -----------
1,521,427 120 1,521,547
----------- ----------- -----------
INCOME BEFORE INCOME TAX
PROVISION (BENEFIT) 720,198 473,578 688,478
Income Tax Provision (Benefit) 214,900 (12,800) 202,100
----------- ----------- -----------
NET INCOME $ 505,298 $ 486,378 $ 486,378
=========== =========== ===========
(i) Certain items have been eliminated in consolidation.
F-44
65
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
CORNERSTONE BANCSHARES, INC.
By: /s/ Earl A. Marler, Jr.
Chairman of the Board and
Chief Executive Officer
Date: April 15, 1998
In accordance with the requirements of the Exchange Act, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Capacity Date
- --------- -------- ----
/s/ Earl A. Marler, Jr. Chairman of the Board, Chief Executive Officer April 15, 1998
and Director (principal executive officer)
/s/ Timothy L. Hobbs President and Director April 15, 1998
/s/Teresa Patten (principal accounting and financial officer) April 15, 1998
/s/Ramesh V. Amin Director April 15, 1998
/s/ Randy Brooks Director April 15, 1998
/s/ B. Kenneth Driver Director April 15, 1998
/s/ Karl Fillauer Director April 15, 1998
/s/ Carolyn C. Johnson Director April 15, 1998
/s/ James H. Large Director April 15, 1998
/s/ Lawrence D. Levine Director April 15, 1998
66
/s/ Russell W. Lloyd Director April 15, 1998
/s/ Doyce G. Payne, M.D. Director April 15, 1998
/s/ Turner Smith Director April 15, 1998
/s/ Billy O. Wiggins Director April 15, 1998
/s/ Marsha Yessick Director April 15, 1998