<PAGE> 1
U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 1999
[ ] TRANSITION REPORT PURSUANT SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
----------------- -------------------
Commission file number 333-26699
CORNERSTONE BANCHSHARES, INC.
(Exact name of small business issuer as specified in its charter)
TENNESSEE 62-1173944
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5319 HIGHWAY 153
CHATTANOOGA, TENNESSEE 37343
(Address of principal executive offices)
(423) 877-8181
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by
Section 12, 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
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: 1,009,961 SHARES OF COMMON
STOCK AS OF MARCH 31, 1999.
<PAGE> 2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CONDITION
<TABLE>
<CAPTION>
Unaudited Unaudited
March 31, December 31, March 31,
------------ ------------ -----------
ASSETS 1999 1998 1998
------------ ------------ -----------
<S> <C> <C> <C>
Cash and due from banks 5,454,637 4,268,967 6,166,368
Federal funds sold 6,445,000 8,425,000 14,310,000
Investment securities available for sale 8,524,813 9,280,116 9,375,520
Investment securities held to maturity 8,024,303 9,077,465 1,687,672
Loans, less allowance for loan loss 67,174,147 72,492,549 63,759,536
Premises and equipment, net 1,940,085 1,967,329 1,955,463
Accrued interest receivable 570,966 638,441 676,599
Excess cost over fair value of assets acquired 2,806,331 2,834,124 2,838,954
Other assets 1,568,554 1,522,143 1,220,424
------------ ------------ -----------
Total assets 102,508,835 110,506,134 108,990,536
============ ============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Non interest bearing 10,396,679 14,151,526 10,975,143
NOW accounts 13,749,522 12,998,223 13,314,076
Savings deposits and money market accounts 9,315,445 10,283,103 10,764,728
Time deposits of $100,000 or more 15,677,132 17,489,618 10,768,783
Time deposits of less than $100,000 40,517,135 43,089,138 51,303,483
------------ ------------ -----------
Total deposits 89,655,913 98,011,608 97,126,213
Accrued interest payable 210,626 270,634 342,958
Other liabilities 913,699 470,861 332,220
Note payable 1,250,000 1,250,000 856,000
------------ ------------ -----------
Total liabilities 92,030,238 100,003,103 98,655,391
------------ ------------ -----------
Redeemable common stock 237,504 478,744 478,744
Stockholders' equity
Common stock 1,009,561 1,009,461 1,009,061
Additional paid-in capital 9,260,418 9,017,430 9,001,716
Undivided profits (deficit) (44,978) (41,695) (202,101)
Net unrealized gain in securities available for sale 16,092 39,091 47,725
------------ ------------ -----------
Total stockholders' equity 10,478,597 10,503,031 10,335,145
------------ ------------ -----------
Total liabilities and stockholders equity 102,508,835 110,506,134 108,990,536
============ ============ ===========
</TABLE>
<PAGE> 3
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Unaudited Unaudited
March 31, March 31,
---------- ---------
1999 1998
---------- ---------
<S> <C> <C>
INTEREST INCOME
Interest and fees on loans 1,577,138 1,561,652
Interest on investment securities 275,936 277,784
Interest on federal funds sold 38,533 85,643
Interest on other earning assets -- --
---------- ---------
Total interest income 1,891,607 1,925,079
---------- ---------
INTEREST EXPENSE
Interest bearing demand accounts 60,781 63,323
Money market accounts 52,070 57,493
Savings accounts 26,629 26,402
Time deposits of less than $100,000 555,771 651,315
Time deposits of $100,000 or more 238,067 167,569
Federal funds purchased 732 570
Securities sold under agreements to repurchase 1,678 --
Other borrowings 24,219 18,169
---------- ---------
Total interest expense 959,947 984,842
---------- ---------
Net interest income 931,660 940,237
Provision for loan losses 50,000 47,018
Net interest income after the provision for loan losses 881,660 893,219
---------- ---------
NONINTEREST INCOME
Service charges on deposit accounts 91,178 97,757
Net securities gains (losses) -- --
Other income 37,031 54,988
---------- ---------
Total noninterest income 128,209 152,745
---------- ---------
NONINTEREST EXPENSE
Salaries and employee benefits 480,345 412,701
Occupancy and equipment expense 128,183 108,388
Other operating expense 382,756 308,859
---------- ---------
Total noninterest expense 991,284 829,949
---------- ---------
Income before provision for income taxes 18,586 216,016
Provision for income taxes 21,868 128,096
---------- ---------
NET INCOME (3,283) 87,919
========== =========
Basic net income per common share (0.00) 0.09
Diluted net income per common share (0.00) 0.08
Dividends declared per common share -- --
</TABLE>
<PAGE> 4
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income (3,283) 87,919
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Provision for possible loan losses 50,000 47,018
Provision for depreciation and amortization -- --
Accrued interest receivable 67,475 (44,114)
Accrued interest payable (60,008) 17,407
Changes in other assets and liabilities: (225,449) (634,872)
----------- -----------
Net cash used in operating activities (171,264) (526,642)
----------- -----------
Cash flows from investing activities:
Purchase of investment securities available for sale (2,316,702) (1,822,040)
Proceeds from security transactions 4,086,499 2,051,829
Net increase in loans 5,318,402 (3,333,193)
Purchase of bank premises and equipment (32,312) (144,215)
Net cash used in investing activities 7,055,887 (3,247,619)
----------- -----------
Cash flows from financing activities:
Net increase in deposits (8,343,937) 15,276,408
Net increase in repurchase agreements 663,135 --
Net increase of notes payable -- --
Issuance of common stock 1,848 1,670,329
----------- -----------
Net cash provided by finanacing activities (7,678,954) 16,946,737
----------- -----------
Net increase in cash and cash equivalents (794,330) 13,172,476
Cash and cash equivalents beginning of period 12,693,967 7,303,892
----------- -----------
Cash and cash equivalents end of period 11,899,637 20,476,368
=========== ===========
(794,330) 13,172,476
</TABLE>
<PAGE> 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CORNERSTONE BANCSHARES, INC.
PRESENTATION OF FINANCIAL INFORMATION
The 1999 financial information in this report has not been audited. The
information included herein should be read in conjunction with the notes to
consolidated financial statements included in the 1998 Annual Report to
Shareholders which was furnished to each shareholder of Cornerstone Bancshares,
Inc. (the "Company" or "Cornerstone") in March 1999. The consolidated financial
statements presented herein conform to generally accepted accounting principles
and to general industry practices.
Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its sole subsidiary Cornerstone Community Bank (the "Bank").
Substantially all intercompany transactions, profits and balances have been
eliminated.
Accounting Policies
During interim periods, the company follows the accounting policies set forth in
its Annual Report on Form 10-K for the year ended December 31, 1998, as filed
with the Securities and Exchange Commission. Since December 1998, there have
been no changes in any accounting principles or practices, or in the method of
applying any such principles or practices.
Interim Financial Data (Unaudited)
In the opinion of the Company 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, cash flows for the interim period. Results for interim periods are
not necessarily indicative of the results to be expected for a full year.
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 (denominator). Diluted EPS is computed by dividing income available
to common shareholders (numerator) by 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.
Forward-Looking Statements
Certain written and oral statements made by or with the approval of an
authorized executive officer of the Company may constitute "forward-looking
statements" as defined under the Private Securities Litigation Reform Act of
1995. Words or phrases such as "should result", "are expected
<PAGE> 6
to," "we anticipate," "we estimate," "we project" or similar expressions are
intended to identify forward-looking statements. These statements are subject to
certain risks and uncertainties that could cause actual results to differ
materially from the Company's historical experience and its present expectations
or projections. These risks and uncertainties include, but are not limited to,
unanticipated economic changes, interest rate movements and the impact of
competition. Caution should be taken not to place undue reliance on any such
forward-looking statements since such statements speak only as of the date of
making such statements.
<PAGE> 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
OVERVIEW
The Company ended the first three months of 1999 with total assets
of $102 million, a 7.3% decrease from December 31, 1998, and a 6.0% decrease
from March 31, 1998. The Company reported net income for the three months ending
March 31, 1999 of $(3,283), or $0.0 basic earnings per share, compared to
$87,919, or $0.09 basic earnings per share, for the same period in 1998. The
decline in earnings represents a 103.7% decrease from the first quarter 1998
compared to the first quarter of 1999.
The decrease in net income from March 1998 to March 1999 is
primarily due a reorganization of the executive staff and an extensive review of
lending and accounting procedures. The result created higher salaries as the
Bank hired expertise needed to remain competitive and in compliance with all
Federal laws. In addition, the Bank incurred higher than normal professional and
legal expenses as management reviewed the loan portfolio and brought the loan
quality back to an acceptable quality level.
FINANCIAL CONDITION
Earning Assets. Average earning assets for March 31, 1999
increased $12.2 million or 15% above March 1998, while actual earning assets
decreased $5.6 million or 5.8% during the same time period. The average balance
increase was primarily due to an expected increase in loans outstanding. The
actual balance decrease was due to a late increase during the quarter in federal
funds in 1998 and a late quarter decrease in loans in 1999.
Loan Portfolio. Cornerstone's average loans for the first three
months of 1999 were $72.2 million, an increase of 16.6%, while actual balances
increased to $68.4 million, an increase of 5.9% over $64.6 million in loans for
the first three months of 1998. Loan growth for 1999 has been primarily funded
through federal funds and reduced investments.
Management is anticipating increased loan growth (more than 10%)
for the remainder of the year in actual balances, with only a relatively small
increase in average balances. However, the amount of such growth, if any, will
depend upon general economic conditions.
Investment Portfolio. Cornerstone's investment securities
portfolio decreased by 9.9% or $1.8 million from March 1998 to March 1999.
Cornerstone maintains an investment strategy of making prudent investment
decisions with active management of the portfolio to optimize, within the
constraints of established policies, an adequate return and value. Investment
objectives include Gap Management, Liquidity, Pledging, Return, and Local
Community Support in that order of priority. 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. As of March
31, 1999, unrealized gains in the "Available for Sale" portfolio amounted to
$24,381.
Deposits. Cornerstone's average deposits increased $5.8 million or
7.7% from March 1998 to March 1999, while actual deposit balances decreased
$7.5 million or 7.7%. The largest
<PAGE> 8
portion of decrease was a $5.9 million, or 9.5% decrease in time deposits. This
is due to Cornerstone's strategy to only pay premium rates for certificates of
deposit when loan growth dictates additional funding. Transaction accounts are
continuously solicited from new customers and existing customers. Transaction
accounts are the Bank's highest priority and will provide the Bank with an
increased net interest margin.
Capital Resources. Stockholders' equity increased $0.2 million or
2.0% to $10.5 million as of March 31, 1999, compared with $10.3 at March 31,
1998. This increase was primarily due to earnings being retained.
RESULTS OF OPERATIONS - QUARTER ENDED MARCH 31, 1999 COMPARED TO QUARTER ENDED
MARCH 31, 1998
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 the first three months of 1999 decreased
$8,574 or 1% below net interest income earned as of March 1998. The decrease in
net interest income as of March 31, 1999 is primarily due to a decrease in the
Bank's net interest spread on earning assets, which dropped from 4.11% to 3.48%
in 1999. Reduced loan yields contributed the majority of the net interest spread
reduction.
Interest income decreased $33,472 or 1.7% as of March 1999
compared to March 1998. Interest income produced by the loan portfolio increased
$15,486 or 1% from March 1998 to March 1999 due to the decrease in average
yields for the period. Two factors contributed to the reduction of loan yields,
first, a general decrease in interest rates and second, increased competition
for existing and new customer loan balances. Interest income on investment
securities and federal funds decreased $48,958 or 13.5% from March 1998 to March
1999, due primarily to reduced balances.
Total interest expense decreased $24,895 or 2.5% from March 31,
1998 to March 31, 1999. The interest expense decrease from the first quarter of
1998 to the first quarter of 1999 is primarily due to the general decrease in
interest rates mentioned above.
The trend in net interest 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 at March 31, 1999 was 4.03%. The yield on
earning assets decreased 115 basis points to 8.19% at March 31, 1999 from 9.34%
at March 31, 1998.
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. As a result of changes in the asset and liability mix during
late 1998
<PAGE> 9
and first quarter 1999, the interest rate spread was 3.48%, a decrease of 63
basis points from March 1998 to March 1999.
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
$1,208,310 for March 1999 in the allowance for loan loss account does not
reflect the full known extent of credit exposure and anticipates adding $500,000
to the allowance during 1999. No assurances 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.
Non-performing Assets. Non-performing assets include
non-performing loans and foreclosed real estate held for sale. Non-performing
loans include loans classified as non-accrual or renegotiated. Cornerstone's
policy is to place a loan on non-accrual 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 non-accrual status, interest previously accrued but not collected
may be reversed and charged against current earnings. As of March 31, 1999
Cornerstone had $1,019,256 in non-accrual loans and $1,255,878 in non-performing
loans.
Non-interest Income. Non-interest 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 loans are included in non-interest income. Excluding gains from the
sale of loans, total non-interest income decreased by $24,536 or 16% from March
1998 to March 1999.
Non-interest Expense. Non-interest expense for the first three
months of 1999 increased by $161,335 or 19.4% as compared to the first three
months in 1998. Salaries and employee benefits increased by $67,644 or 16.4% in
March 1999 over March 1998. Occupancy expense as of March 31, 1999 increased by
$19,795 or 18.3% over the same period in 1998. All other non-interest expenses
at March 31, 1999 increased $73,897 or 24% over the non-interest expenses as of
March 31, 1998, primarily due to an increase in director fees, professional
fees, and miscellaneous charge-offs.
<PAGE> 10
YEAR 2000 COMPLIANCE
The Year 2000 poses serious challenges to the banking industry. Many
experts believe that even the most prepared organizations may encounter some
implementation problems. The federal banking agencies are concerned that
financial institutions avoid major disruptions to service and operations. All
banks are required to have an action plan to address Year 2000 issues which must
include an indication of management awareness of the problems and the commitment
to solutions; identification of external risks; and operational issues that are
relevant to a bank's Year 2000 planning.
The Federal Financial Institutions Examination Council ("FFIEC") has
issued guidelines and target time frames to accomplish critical actions
concerning Year 2000 compliance:
* By September 30, 1997, all banks should have identified affected
applications and databases. Mission critical applications should be identified
and an action plan set for Year 2000 work.
* By December 31, 1998, code enhancements and revisions, hardware
upgrades, and other associated changes should have been largely completed by all
banks. In addition, for mission critical applications, programming changes
should have been largely completed and testing should be well underway.
* Between January 1, 1999 and December 31, 1999, banks should be
testing and implementing their Year 2000 conversion programs.
External factors which may adversely affect Cornerstone include
reliance on vendors, such as third-party data processing services and software
and hardware vendors; electronic data-sensitive exchange among other financial
institutions which may not be Year 2000 compliant; corporate customers of
Cornerstone and other debtors.
Cornerstone has been assessing its state of readiness by evaluating its
information technology ("IT") and non-IT systems. IT systems commonly include
data processing, accounting and telephone systems. With respect to its IT
systems, Cornerstone estimates that its Year 2000 identification, assessment and
remediation efforts are substantially complete. During 1999, further testing
will be carried out in order to ensure that all systems are working properly.
Cornerstone has assessed its Year 2000 status in regard to non-IT systems and
has determined that no material risk exists.
Cornerstone has communicated with its significant vendors in order to
determine the extent to which interfaces with such entities are vulnerable to
Year 2000 issues and whether the products and services purchased from such
entities are Year 2000 compliant. Cornerstone has received either verbal or
written assurance from these vendors that they expect to address all their
significant Year 2000 issues on a timely basis. With respect to significant
borrowers and depositors, Cornerstone does not anticipate any material Year 2000
issues.
Cornerstone believes the cost of its Year 2000 identification,
assessment, remediation and testing efforts will not exceed $10,000.
<PAGE> 11
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults on Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and reports on Form 8-K
(a) Exhibits:
Financial Data Schedule (For SEC Use Only)
(b) There have been no Current Reports on Form 8-K during the quarter
ended March 31, 1999.
<PAGE> 12
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Date: May 14, 1999
/s/Gregory B. Jones, President & CEO
Date: May 14, 1999
/s/Nathaniel F. Hughes, CFO
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY FOR THE
THREE MONTHS ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 5,454,637
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 6,445,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 8,024,303
<INVESTMENTS-MARKET> 8,524,813
<LOANS> 68,382,457
<ALLOWANCE> 1,208,310
<TOTAL-ASSETS> 102,508,835
<DEPOSITS> 89,655,913
<SHORT-TERM> 1,250,000
<LIABILITIES-OTHER> 1,124,315
<LONG-TERM> 0
0
0
<COMMON> 1,009,461
<OTHER-SE> 9,231,532
<TOTAL-LIABILITIES-AND-EQUITY> 102,508,835
<INTEREST-LOAN> 1,577,138
<INTEREST-INVEST> 275,936
<INTEREST-OTHER> 38,533
<INTEREST-TOTAL> 1,891,607
<INTEREST-DEPOSIT> 933,318
<INTEREST-EXPENSE> 26,629
<INTEREST-INCOME-NET> 931,660
<LOAN-LOSSES> 50,000
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 991,284
<INCOME-PRETAX> 18,586
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,283)
<EPS-PRIMARY> (0.00)
<EPS-DILUTED> (0.00)
<YIELD-ACTUAL> 4.25
<LOANS-NON> 1,019,256
<LOANS-PAST> 67,661
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,400,000
<CHARGE-OFFS> 304,209
<RECOVERIES> 62,520
<ALLOWANCE-CLOSE> 1,208,310
<ALLOWANCE-DOMESTIC> 1,208,310
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
