10-Q 1 v157924_10q.htm Unassociated Document
United States Securities and Exchange Commission
Washington, D.C. 20549

FORM 10-Q

(Mark One)

x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2009
   
¨
TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________to

Commission File Number: 000-30497


(Exact name of small business issuer as specified in its charter)

Tennessee
 
62-1173944
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
835 Georgia Avenue Chattanooga, Tennessee
 
37402
(Address of principal executive offices)
 
(Zip Code)
     
423-385-3000
 
Not Applicable
(Registrant’s telephone number, including area code)
 
(Former name, former address and former fiscal
year, if changes since last report)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer", “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large accelerated filer  ¨     Accelerated filer  ¨     Non-accelerated filer  ¨     Smaller reporting company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  ¨    No  x

As of July 28, 2009 there were 6,372,937 shares of common stock, $1.00 par value per share, issued and outstanding.

 

 
 
TABLE OF CONTENTS

PART I –FINANCIAL INFORMATION
   
Item 1.  Financial Statements (Unaudited)
  4
   
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
17
   
Item 3.  Quantitative and Qualitative Disclosures about Market Risk
24
   
Item 4T.Controls and Procedures
  24
   
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
  24
   
Item 1A. Risk Factors
  24
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  24
   
Item 3. Defaults Upon Senior Securities
  24
   
Item 4. Submission of Matters to a Vote of Security Holders
  24
   
Item 5. Other Information
  25
   
Item 6. Exhibits
  25
 
 
2

 
 
FORWARD-LOOKING STATEMENTS

Cornerstone Bancshares, Inc. (“Cornerstone”) may from time to time make written or oral statements, including statements contained in this report which constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). Forward-looking statements are those not based on historical information, but rather related to future operations, strategies, financial results or other developments.  Generally, the words “expect,” “anticipate,” “intend,” “consider,” “plan,” “believe,” “seek,” “should,” “estimate,” and similar expressions may be used to identify such forward-looking statements, but other statements may constitute forward-looking statements. These statements are subject to various risks and uncertainties. Such forward-looking statements are made based upon management’s belief as well as assumptions made by, and information currently available to, management and speak only as of the date made.  Cornerstone’s actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors. Such factors include, without limitation, those specifically described in Item 1A of Part II of this report and in Cornerstone’s Annual Report on Form 10-K for the year ended December 31, 2008, as well as the following:  (i) unanticipated deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses, (ii) increased competition with other financial institutions, (iii) lack of sustained growth in the economy in the Chattanooga, Tennessee area, (iv) rapid fluctuations or unanticipated changes in interest rates, (v) the inability of our bank subsidiary, Cornerstone Community Bank, to satisfy regulatory requirements for its expansion plans, (vi) the inability of Cornerstone to achieve its targeted expansion goals in the Dalton, Georgia  market, (vii) the inability of Cornerstone to grow its loan portfolio at historic or planned rates and (viii) changes in the legislative and regulatory environment, including compliance with the various provisions of the Sarbanes-Oxley Act of 2002. Many of such factors are beyond Cornerstone’s ability to control or predict, and readers are cautioned not to put undue reliance on such forward-looking statements. Cornerstone does not intend to update or reissue any forward-looking statements contained in this report as a result of new information or other circumstances that may become known to Cornerstone.

 
3

 
 
Cornerstone Bancshares, Inc. and Subsidiary
Consolidated Balance Sheets

PART I — FINANCIAL INFORMATION
Item 1.
Financial Statements

   
Unaudited
       
   
June 30,
   
December 31,
 
   
2009
   
2008
 
 ASSETS
               
Cash and due from banks
  $ 34,306,722     $ 10,872,390  
Federal funds sold
    -       11,025,000  
Cash and cash equivalents
    34,306,722       21,897,390  
                 
Securities available for sale
    45,699,449       44,056,559  
Securities held to maturity
    154,426       169,284  
Federal Home Loan Bank stock, at cost
    2,229,200       2,187,500  
Loans, net of allowance for loan losses of $7,383,314 at June 30, 2009 and $9,618,265 at December 31, 2008
    353,231,930       378,471,619  
Bank premises and equipment, net
    8,104,060       8,471,955  
Accrued interest receivable
    1,414,384       1,771,091  
Goodwill and amortizable intangibles
    2,562,760       2,840,773  
Other assets
    16,795,842       11,937,004  
Total Assets
  $ 464,498,773     $ 471,803,175  
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
             
Deposits:
               
Noninterest-bearing demand deposits
  $ 42,146,564     $ 40,077,977  
Interest-bearing demand deposits
    30,398,515       26,908,572  
Savings deposits and money market accounts
    31,639,974       35,847,667  
Time deposits of $100,000 or more
    65,244,121       59,056,590  
Time deposits of less than $100,000
    167,610,525       164,692,417  
Total deposits
    337,039,699       326,583,223  
Federal funds purchased and securities sold under agreements to repurchase
    20,526,479       35,790,246  
Federal Home Loan Bank advances  and line of credit
    72,350,000       71,250,000  
Accrued interest payable
    651,368       469,586  
Other liabilities
    1,232,141       1,208,611  
Total Liabilities
    431,799,687       435,301,666  
                 
Stockholders' Equity:
               
Preferred stock - no par value; 2,000,000 shares authorized; no shares issued
    -       -  
Common stock - $l.00 par value; 10,000,000 shares authorized;6,522,718 issued in 2009 and 2008; 6,319,718 outstanding in 2009 and 2008
    6,319,718       6,319,718  
Additional paid-in capital
    20,421,034       20,311,638  
Retained earnings
    5,904,317       10,056,680  
Accumulated other comprehensive income
    54,017       (186,527 )
Total Stockholders' Equity
    32,699,086       36,501,509  
Total Liabilities and Stockholders' Equity
  $ 464,498,773     $ 471,803,175  
 
The Notes to Consolidated Financial Statements are an integral part of these statements.

 
4

 
 
Cornerstone Bancshares, Inc. and Subsidiary
Consolidated Statements of Income

   
Unaudited
   
Unaudited
 
   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
INTEREST INCOME
                       
Loans, including fees
  $ 6,035,104     $ 7,199,680     $ 12,477,209     $ 14,752,975  
Investment securities
    386,065       553,103       800,126       1,051,112  
Federal funds sold
    6,697       4,122       14,646       12,881  
Total interest income
    6,427,866       7,756,905       13,291,981       15,816,968  
                                 
INTEREST EXPENSE
                               
Interest bearing demand accounts
    29,960       56,570       56,154       123,397  
Money market accounts
    69,642       191,671       149,288       529,524  
Savings accounts
    10,247       15,379       20,010       31,186  
Time deposits of  more than $100,000
    480,917       685,347       1,010,094       1,513,092  
Time deposits of less than $100,000
    1,388,223       1,421,289       2,854,235       2,828,224  
Federal funds purchased and securities sold under agreements to repurchase
    43,880       170,985       97,929       344,785  
Other borrowings
    768,199       682,208       1,474,035       1,323,121  
Total interest expense
    2,791,068       3,223,449       5,661,745       6,693,329  
                                 
Net interest income before provision for loan losses
    3,636,798       4,533,456       7,630,236       9,123,639  
Provision for loan losses
    1,633,898       170,000       7,358,898       487,000  
Net interest income after the provision for loan losses
    2,002,900       4,363,456       271,338       8,636,639  
                                 
NONINTEREST INCOME
                               
Service charges
    434,595       433,489       842,738       838,820  
Net gains / (losses) from sale of loans and other assets
    146,613       61,779       (34,248 )     9,531  
Other income
    149,083       29,304       184,915       70,526  
Total noninterest income
    730,291       524,572       993,405       918,877  
                                 
NONINTEREST EXPENSE
                               
Salaries and employee benefits
    1,848,452       1,834,678       3,690,127       3,675,710  
Occupancy and equipment expense
    387,897       383,173       796,836       763,054  
Other operating expense
    1,537,010       998,140       2,579,138       1,873,851  
Total noninterest expense
    3,773,359       3,215,991       7,066,101       6,312,615  
                                 
Income / (loss) before provision for income taxes
    (1,040,168 )     1,672,037       (5,801,358 )     3,242,901  
Provision / (benefit)  for income taxes
    (437,369 )     598,981       (2,287,056 )     1,154,988  
                                 
NET INCOME / (LOSS)
  $ (602,799 )   $ 1,073,056     $ (3,514,302 )   $ 2,087,913  
                                 
EARNINGS / (LOSS) PER COMMON SHARE
                               
Basic net income / ( loss) per common share
  $ (0.10 )   $ 0.17     $ (0.56 )   $ 0.33  
Diluted net income / (loss) per common share
  $ (0.10 )   $ 0.17     $ (0.56 )   $ 0.32  
                                 
DIVIDENDS DECLARED PER COMMON SHARE
  $ 0.03     $ 0.07     $ 0.10     $ 0.14  

The Notes to Consolidated Financial Statements are an integral part of these statements.
 
5

 
Cornerstone Bancshares, Inc. and Subsidiary
Consolidated Statement of Changes in Stockholders' Equity - Unaudited
For the six months ended June 30, 2009

               
Additional
         
Other
   
Total
 
   
Comprehensive
   
Common
   
Paid-in
   
Retained
   
Comprehensive
   
Stockholders'
 
   
Income
   
Stock
   
Capital
   
Earnings
   
Income
   
Equity
 
                                     
BALANCE, December 31, 2008
        $ 6,319,718     $ 20,311,638     $ 10056680     $ (186,527 )   $ 36,501,509  
                                               
Employee compensation stock option expense
          -       109,396       -       -       109,396  
                                               
Dividend - $0.10 per share
          -       -       (638,061 )     -       (638,061 )
                                               
Comprehensive income / (loss):
                                             
Net loss
  $ (3,514,302 )     -       -       (3,514,302 )     -       (3,514,302 )
                                                 
Other comprehensive income, net of tax: Unrealized holding gains (losses) on securities available for sale, net of reclassification adjustment
    240,544       -       -       -       240,544       240,544  
                                                 
Total comprehensive loss
  $ (3,273,758 )                                        
                                                 
BALANCE, June 30, 2009
          $ 6,319,718     $ 20,421,034     $ 5,904,317     $ 54,017     $ 32,699,086  

The Notes to Consolidated Financial Statements are an integral part of these statements.
 
6

 
Cornerstone Bancshares, Inc. and Subsidiary
Consolidated Statements of Cash Flows

   
Unaudited
 
   
Six months ended June 30,
 
   
2009
   
2008
 
             
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net income / (loss)
  $ (3,514,302 )   $ 2,087,913  
Adjustments to reconcile net income / (loss) to net cash (used in) provided by operating activities:
               
Depreciation and amortization
    500,824       281,590  
Provision for loan losses
    7,358,898       487,000  
Stock compensation expense
    109,396       139,800  
Net (Gains) / Losses on sales of loans and other assets
    34,248       (9,531 )
Deferred income taxes
    670,271       3,181,110  
Changes in other operating assets and liabilities:
               
Net change in loans held for sale
    (545,700 )     202,900  
Accrued interest receivable
    356,707       611,987  
Accrued interest payable
    181,782       77,315  
Other assets and liabilities
    (3,368,156 )     (7,716,437 )
Net cash provided by (used in) operating activities
    1,783,968       (656,353 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Proceeds from security transactions:
               
Securities available for sale
    27,916,257       17,222,653  
Securities held to maturity
    14,603       16,213  
Purchase of securities available for sale
    (29,228,921 )     (28,320,718 )
Purchase of Federal Home Loan Bank stock
    (41,700 )     (187,500 )
Loan originations and principal collections, net
    14,950,859       (2,186,712 )
Purchase of bank premises and equipment
    (92,128 )     (267,170 )
Proceeds from sale of other real estate and other assets
    1,698,445       -  
Net cash provided by (used in) investing activities
    15,217,415       (13,723,234 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Net increase in deposits
    10,456,476       756,291  
(Decrease) in federal funds purchased and securities sold under agreements to repurchase
    (15,263,767 )     (6,230,229 )
Net proceeds from Federal Home Loan Bank advances and other borrowings
    1,100,000       19,350,000  
Purchase of common stock
    -       (503,006 )
Payment of dividends
    (884,760 )     (888,260 )
Net cash (used in) provided by financing activities
    (4,592,051 )     12,484,796  
                 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    12,409,332       (1,894,791 )
                 
CASH AND CASH EQUIVALENTS, beginning of period
    21,897,390       14,933,349  
CASH AND CASH EQUIVALENTS, end of period
  $ 34,306,722     $ 13,038,558  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
Cash paid during the period for interest
  $ 5,479,963     $ 6,616,014  
Cash paid during the period for taxes
    -       582,500  
                 
NONCASH INVESTING AND FINANCING ACTIVITIES
               
Acquisition of real estate through foreclosure
  $ 3,594,574     $ -  

The Notes to Consolidated Financial Statements are an integral part of these statements.
 
7

 
 
 
CORNERSTONE BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
 
Note 1. Presentation of Financial Information

Nature of Business-Cornerstone Bancshares, Inc. (“Cornerstone”) is a bank holding company whose primary business is performed by its wholly-owned subsidiary, Cornerstone Community Bank (“Bank”).  The Bank provides a full range of banking services to the Chattanooga, Tennessee market.  The Bank has also established a loan production office (“LPO”) in Dalton, Georgia to further enhance the Bank’s lending markets.  The Bank specializes in asset based lending, commercial lending and payment processing.   The Bank has a wholly-owned subsidiary, Eagle Financial, Inc. (“Eagle”) which specializes in finance and accounts receivable factoring.

Interim Financial Information (Unaudited)-The financial information in this report for June 30, 2009 and June  30, 2008 has not been audited. The information included herein should be read in conjunction with the annual consolidated financial statements and footnotes thereto included in the 2008 Annual Report to Shareholders which was furnished to each shareholder of Cornerstone in March of 2009. The consolidated financial statements presented herein conform to generally accepted accounting principles and to general industry practices.  In the opinion of Cornerstone’s management, the accompanying interim financial statements contain all material adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial condition, the results of operations, and cash flows for the interim period. Results for interim periods are not necessarily indicative of the results to be expected for a full year.

Use of Estimates-The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term include the determination of the allowance for loan losses.

Consolidation-The accompanying consolidated financial statements include the accounts of Cornerstone and its wholly-owned subsidiary Bank.  Substantially all intercompany transactions, profits and balances have been eliminated.

Reclassification-Certain amounts in the prior consolidated financial statements have been reclassified to conform to the current period presentation.  The reclassifications had no effect on net income or stockholder’s equity as previously reported.

Accounting Policies-During interim periods, Cornerstone follows the accounting policies set forth in its Annual Report on Form 10-K for the year ended December 31, 2008 as filed with the Securities and Exchange Commission.  Since December 31, 2008, there have been no significant changes in any accounting principles or practices, or in the method of applying any such principles or practices.

Earnings per Common Share- Basic earnings per share (“EPS”) is computed by dividing income available to common shareholders (numerator) by the weighted average number of common shares outstanding during the period (denominator). Diluted EPS is computed by dividing income available to common shareholders (numerator) by the adjusted weighted average number of shares outstanding (denominator). The adjusted weighted average number of shares outstanding reflects the potential dilution occurring if securities or other contracts to issue common stock were exercised or converted into common stock resulting in the issuance of common stock that share in the earnings of the entity.

 
8

 

CORNERSTONE BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

The following is a summary of the basic and diluted earnings per share for the three month periods ended June 30, 2009 and 2008.

   
Three Months Ended June 30,
 
Basic earnings / (loss) per share calculation:
 
2009
   
2008
 
Numerator: Net income / (loss) available to common shareholders
  $ (602,799 )   $ 1,073,056  
Denominator: Weighted avg. common shares outstanding
    6,319,718       6,319,718  
Effect of dilutive stock options
    -       168,579  
Diluted shares
    6,319,718       6,488,297  
                 
Basic earnings / (loss) per share
  $ (0.10 )   $ 0.17  
Diluted earnings / (loss) per share
  $ (0.10 )   $ 0.17  

The following is a summary of the basic and diluted earnings per share for the six month periods ended June 30, 2009 and 2008.

   
Six Months Ended June 30,
 
Basic earnings / (loss) per share calculation:
 
2009
   
2008
 
Numerator: Net income / (loss) available to common shareholders
  $ (3,514,302 )   $ 2,087,913  
Denominator: Weighted avg. common shares outstanding
    6,319,718       6,328,234  
Effect of dilutive stock options
    -       199,288  
Diluted shares
    6,319,718       6,527,522  
                 
Basic earnings / (loss) per share
  $ (0.56 )   $ 0.33  
Diluted earnings / (loss) per share
  $ (0.56 )   $ 0.32  

Note 2. Stock Based Compensation

Accounting Policies- Cornerstone, as required by FASB, applies the fair value recognition provisions of SFAS No. 123(R) Share-Based Payment.  As a result, for the six month period ended June 30, 2009, the compensation cost charged to earnings related to the vested incentive stock options was approximately $109,000, which reduced basic earnings per share by $0.02 per share.

Officer and Employee Plans-Cornerstone has two stock option plans under which officers and employees can be granted incentive stock options or non-qualified stock options to purchase a total of up to 1,420,000 shares of Cornerstone’s common stock.  The option price for incentive stock options shall be not less than 100 percent of the fair market value of the common stock on the date of the grant.  The exercise price of the non-qualified stock options may be equal to or more or less than the fair market value of the common stock on the date of the grant.  The stock options vest at 30 percent on the second and third anniversaries of the grant date and 40 percent on the fourth anniversary.  The options expire ten years from the grant date.  At June 30, 2009, the total remaining compensation cost to be recognized on non-vested options was approximately $592,000.  A summary of the status of these stock option plans is presented in the following table:

             
Weighted-
       
             
Average
       
         
Weighted
 
Contractual
       
         
Average
 
Remaining
   
Aggregate
 
         
Exercisable
 
Term
   
Intrinsic
 
   
Number
   
Price
 
(in years)
   
Value
 
Outstanding at December 31, 2008
    755,425     $ 6.63  
5.0 Years
    $ 1,634,022  
      Granted
    115,850       3.60              
      Exercised
    -       -              
      Forfeited
    (25,400 )     4.69              
Outstanding at June 30, 2009
    845,875     $ 6.27  
5.3 Years
    $ 681,619  
Options exercisable at June 30, 2009
    595,378     $ 5.46              
 
 
9

 

CORNERSTONE BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

The weighted average grant-date fair value of stock options granted during the six months ended June 30, 2009 was $1.13.  This was determined using the Black-Scholes option pricing model with the following weighted –average assumptions:  Dividend Yield-2.97%, Expected Life-7.0 years, Expected Volatility-38.74%, Risk-free Interest Rate- 2.69%.

Board of Directors Plan-Cornerstone has a stock option plan under which members of the Board of Directors, at the formation of the Bank, were granted options to purchase a total of up to 600,000 shares of the Bank's common stock.  On October 15, 1997, the Bank stock options were converted to Cornerstone stock options.  Only non-qualified stock options may be granted under the Plan.  The exercise price of each option equals the market price of Cornerstone’s stock on the date of grant and the option’s maximum term is ten years.  Vesting for options granted during 2009, are 50% on the first and second anniversary of the grant date.  At June 30, 2009, the total remaining compensation cost to be recognized on non-vested options was approximately $52,000.  A summary of the status of this stock option plan is presented in the following table:

             
Weighted-
       
             
Average
       
         
Weighted
 
Contractual
       
         
Average
 
Remaining
   
Aggregate
 
         
Exercisable
 
Term
   
Intrinsic
 
   
Number
   
Price
 
(in years)
   
Value
 
Outstanding at December 31, 2008
    81,800     $ 10.73  
7.9 Years
    $ 29,608  
      Granted
    20,500       3.60              
      Exercised
    -       -              
      Forfeited
    -       -              
Outstanding at June 30, 2009
    102,300     $ 9.30  
7.8 Years
    $ 29,487  
Options exercisable at June 30, 2009
    75,400     $ 10.96              

The weighted average grant-date fair value of stock options granted during the six months ended June 30, 2009 was $1.13.  This was determined using the Black-Scholes option pricing model with the following weighted –average assumption:  Dividend Yield-2.97%, Expected Life-7.0 years, Expected Volatility-38.74%, Risk-free Interest Rate- 2.69%.

Note 3. Stockholder’s Equity

During 2009, Cornerstone’s Board of Directors declared the following cash dividends:

Cash Dividend Rate
 
Declaration Date
 
Record Date
 
Payment Date
 
(per share) 
           
$ 0.07  
February 25, 2009
 
March 13, 2009
 
April 3, 2009
$ 0.03  
June 2, 2009
 
June 12, 2009
 
July 3, 2009

Any determinations relating to future dividends will be made at the discretion of Cornerstone’s Board of Directors and will depend on a number of factors, including our earnings, capital requirements, financial conditions, future prospects, regulatory restrictions and other factors that Cornerstone’s Board of Directors may deem relevant.

 
10

 

  CORNERSTONE BANCSHARES, INC.
  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 4. Securities

The amortized cost and fair value of securities available-for-sale and held-to-maturity at June 30, 2009 and December 31, 2008 are summarized as follows:

   
June 30, 2009
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Market
 
Securities Available-for-Sale:
 
Cost
   
Gains
   
Losses
   
Value
 
    U.S. Government securities
  $ 8,292,245     $ -     $ (66,997 )   $ 8,225,248  
                                 
    State and municipal securities
    6,380,664       163,914       (42,116 )     6,502,462  
                                 
    Mortgage-backed securities
    30,944,696       191,104       (164,061 )     30,971,739  
                                 
    $ 45,617,605     $ 355,018     $ (273,174 )   $ 45,699,449  
Securities Held-to-Maturity:
                               
    Mortgage-backed securities
  $ 154,426     $ 1,189     $ (131 )   $ 155,484  
 
   
December 31, 2008
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Market
 
Securities Available-for-Sale:
 
Cost
   
Gains
   
Losses
   
Value
 
    U.S. Government securities
  $ 7,976,040     $ 275,731     $ -     $ 8,251,771  
                                 
    State and municipal securities
    4,609,632       82,013       (68,830 )     4,622,815  
                                 
    Mortgage-backed securities
    31,753,504       160,387       (731,918 )     31,181,973  
                                 
    $ 44,339,176     $ 518,131     $ (800,748 )   $ 44,056,559  
Securities Held-to-Maturity:
                               
    Mortgage-backed securities
  $ 169,284     $ 1,158     $ (683 )   $ 169,759  

    At June 30, 2009, approximately $44 million of Cornerstone’s investment portfolio was pledged to secure public funds, securities sold under agreements to repurchase and serve as collateral for borrowings at the Federal Reserve Discount Window.

 
11

 

CORNERSTONE BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 5. Loans and Allowance for Loan Losses

At June 30, 2009 and December 31, 2008, loans are summarized as follows (in thousands):

   
June 30, 2009
   
December 31, 2008
 
   
Amount
   
Percent
   
Amount
   
Percent
 
Commercial, financial and agricultural
  $ 66,994       18.6 %   $ 83,140       21.4 %
Real estate-construction
    61,553       17.1 %     70,456       18.2 %
Real estate-mortgage
    72,141       20.0 %     72,737       18.7 %
Real estate-commercial
    155,148       43.0 %     155,728       40.1 %
Consumer loans
    4,779       1.3 %     6,029       1.6 %
Total loans
  $ 360,615       100.0 %   $ 388,090       100.0 %

A summary of transactions in the allowance for loan losses for the six months ended June 30, 2009 and year ended December 31, 2008 is as follows (in thousands):

   
June 30,
   
December 31,
 
   
2009
   
2008
 
Balance, beginning of period
  $ 9,618     $ 13,710  
     Loans charged-off
    (9,783 )     (7,979 )
     Recoveries of loans previously charged-off
    189       389  
     Provision for loan losses
    7,359       3,498  
Balance, end of period
  $ 7,383     $ 9,618  
 
Note 6. Commitments and Contingent Liabilities

In the normal course of business, the Bank has entered into off-balance sheet financial instruments which include commitments to extend credit (i.e., including unfunded lines of credit) and standby letters of credit. Commitments to extend credit are usually the result of lines of credit granted to existing borrowers under agreements that the total outstanding indebtedness will not exceed a specific amount during the term of the indebtedness. Typical borrowers are commercial concerns that use lines of credit to supplement their treasury management functions, thus their total outstanding indebtedness may fluctuate during any time period based on the seasonality of their business and the resultant timing of their cash flows. Other typical lines of credit are related to home equity loans granted to consumers. Commitments to extend credit generally have fixed expiration dates or other termination clauses and may require payment of a fee.

Standby letters of credit are generally issued on behalf of an applicant (our customer) to a specifically named beneficiary and are the result of a particular business arrangement that exists between the applicant and the beneficiary. Standby letters of credit have fixed expiration dates and are usually for terms of two years or less unless terminated beforehand due to criteria specified in the standby letter of credit. A typical arrangement involves the applicant routinely being indebted to the beneficiary for such items as inventory purchases, insurance, utilities, lease guarantees or other third party commercial transactions. The standby letter of credit would permit the beneficiary to obtain payment from the  Bank under certain prescribed circumstances. Subsequently, the Bank would then seek reimbursement from the applicant pursuant to the terms of the standby letter of credit.
     
The Bank follows the same credit policies and underwriting practices when making these commitments as it does for on-balance sheet instruments. Each customer’s creditworthiness is evaluated on a case-by-case basis, and the amount of collateral obtained, if any, is based on management’s credit evaluation of the customer. Collateral held varies but may include cash, real estate and improvements, marketable securities, accounts receivable, inventory, equipment, and personal property.

 
12

 

CORNERSTONE BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

The contractual amounts of these commitments are not reflected in the consolidated financial statements and would only be reflected if drawn upon. Since many of the commitments are expected to expire without being drawn upon, the contractual amounts do not necessarily represent future cash requirements. However, should the commitments be drawn upon and should our customers default on their resulting obligation to us, the Bank’s maximum exposure to credit loss, without consideration of collateral, is represented by the contractual amount of those instruments.

A summary of the Bank’s total contractual amount for all off-balance sheet commitments at June 30, 2009 is as follows:

Commitments to extend credit
$
 49.1 million
Standby letters of credit
$
 3.4 million

Various legal claims also arise from time to time in the normal course of business. In the opinion of management, the resolution of claims outstanding at June 30, 2009 will not have a material effect on Cornerstone’s consolidated financial statements.

Note 7. Fair Value Disclosures

Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument.  These estimates do not reflect any premium or discount that could result from offering for sale at one time Cornerstone's entire holdings of a particular financial instrument.  Because no market exists for a significant portion of Cornerstone’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.  These estimates are subjective in nature; involve uncertainties and matters of judgment; and, therefore, cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.  The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

Cash and cash equivalents:

For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.

Securities:

The fair value of securities is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers.

Federal Home Loan Bank stock:

The carrying amount of Federal Home Loan Bank stock approximates fair value based on the stock redemption provisions of the Federal Home Loan Bank.

Loans, net:

The fair value of loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates, adjusted for credit risk and servicing costs.  The estimate of maturity is based on historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions.

Deposits:

The fair value of deposits with no stated maturity, such as demand deposits, money market accounts, and savings deposits, is equal to the amount payable on demand.  The fair value of time deposits is based on the discounted value of contractual cash flows.  The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

 
13

 

CORNERSTONE BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Federal funds purchased and securities sold under agreements to repurchase:

The fair value of these liabilities, which are extremely short term, approximates their carrying value.

Federal Home Loan Bank advances and line of credit:

The carrying amounts of the FHLB advances and the line of credit approximate their fair value.

Commitments to extend credit:

The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.  For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

The carrying amount and estimated fair value of Cornerstone's financial instruments at June 30, 2009 is follows (in thousands):

   
June 30, 2009
 
   
Carrying
   
Estimated
 
   
Amount
   
Fair Value
 
Assets:
           
    Cash and cash equivalents
  $ 34,307     $ 34,307  
    Securities
    45,854       45,855  
    Federal Home Loan Bank Stock
    2,229       2,229  
    Loans, net
    353,232       355,740  
                 
Liabilities:
               
    Noninterest –bearing demand deposits
    42,147       42,147  
    Interest-bearing demand deposits
    30,399       30,399  
    Savings deposits and money market accounts
    31,640       31,640  
    Time deposits
    232,855       236,044  
    Federal funds purchased and securities
               
        sold under agreements to repurchase
    20,526       20,526  
    Federal Home Loan Bank advances
               
       And line of credit
    72,350       72,350  
                 
    Unrecognized financial instruments
               
        (net of contract amount):
               
             Commitments to extend credit
    -       -  
 
 
14

 
 
CORNERSTONE BANCSHARES, INC.
CONSOLIDATED AVERAGE BALANCE
INTEREST INCOME/EXPENSE AND
YIELD/RATES
Taxable Equivalent Basis
 
Three months ended
 
(in thousands)
 
June 30
 
                                     
Assets
 
2009
   
2008
 
   
Average
   
Income/
   
Yield/
   
Average
   
Income/
   
Yield/
 
Earning assets:
 
Balance
   
Expense
   
Rate
   
Balance
   
Expense
   
Rate
 
Loans, net of unearned income
  $ 370,524     $ 6,035       6.53 %   $ 384,487     $ 7,200       7.51 %
Investment securities
    56,849       386       2.91 %     48,549       553       4.69 %
Other earning assets
    11,089       7       0.24 %     592       4       2.79 %
Total earning assets
    438,461     $ 6,428       5.90 %     433,628     $ 7,757       7.19 %
Allowance for loan losses
    (9,326 )                     (7,515 )                
Cash and other assets
    30,509                       26,132                  
TOTAL ASSETS
  $ 459,645                     $ 452,245                  
                                                 
Liabilities and Shareholders' Equity
                                               
                                                 
Interest bearing liabilities:
                                               
Interest bearing demand deposits
  $ 31,702     $ 30       0.38 %   $ 31,434     $ 56       0.72 %
Savings deposits
    8,101       10       0.51 %     7,857       16       0.79 %
MMDA's
    28,754       70       0.97 %     46,391       192       1.66 %
Time deposits of $100,000 or less
    165,234       1,388       3.37 %     124,024       1,421       4.60 %
Time deposits of $100,000 or more
    57,502       481       3.36 %     57,895       685       4.75 %
Federal funds purchased and securities sold under agreements to repurchase
    22,479       44       0.78 %     35,817       169       1.89 %
Other borrowings
    72,454       768       4.25 %     69,475       684       3.95 %
Total interest bearing liabilities
    386,226       2,791       2.90 %     372,893       3,223       3.47 %
Net interest spread
          $ 3,637       3.01 %           $ 4,533       3.72 %
Noninterest bearing demand deposits
    42,752                       42,375                  
Accrued expenses and other liabilities
    (3,190 )                     (372 )                
Shareholders' equity
    33,857                       37,350                  
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
  $ 459,645                     $ 452,245                  
Net yield on earning assets
                    3.35 %                     4.21 %
                                                 
Taxable equivalent adjustment:
                                               
Loans
            0                       0          
Investment securities
            26                       14          
Total adjustment
          $ 26                     $ 14          
 
15

 
CORNERSTONE BANCSHARES, INC.
CONSOLIDATED AVERAGE BALANCE
INTEREST INCOME/EXPENSE AND
YIELD/RATES
Taxable Equivalent Basis
 
Six Months Ended
 
(in thousands)
 
June 30
 
                                     
Assets
 
2009
   
2008
 
   
Average
   
Income/
   
Yield/
   
Average
   
Income/
   
Yield/
 
Earning assets:
 
Balance
   
Expense
   
Rate
   
Balance
   
Expense
   
Rate
 
Loans, net of unearned income
  $ 377,095     $ 12,477       6.67 %   $ 385,294     $ 14,753       7.72 %
Investment securities
    54,976       800       3.12 %     45,392       1,051       4.82 %
Other earning assets
    12,517       15       0.24 %     394       13       6.60 %
Total earning assets
    444,588     $ 13,292       6.05 %     431,080     $ 15,817       7.42 %
Allowance for loan losses
    (9,232 )                     (9,403 )                
Cash and other assets
    29,469                       27,682                  
TOTAL ASSETS
  $ 464,825                     $ 449,359                  
                                                 
Liabilities and Shareholders' Equity