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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 4, 2000
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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CORNERSTONE BANCSHARES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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TENNESSEE 6021 62-1173944
<S> <C> <C>
(state or other jurisdiction of incorporation (Primary Standard Classification (IRS Employer
or organization) Code Number) Identification No.)
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5319 HIGHWAY 153
CHATTANOOGA, TENNESSEE 37343
(423) 385-3000
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
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GREGORY B. JONES
PRESIDENT AND CHIEF EXECUTIVE OFFICER
5319 HIGHWAY 153
CHATTANOOGA, TENNESSEE 37343
(423) 385-3000
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
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WITH COPIES TO:
NATHANIEL F. HUGHES LINDA M. CROUCH, ESQ.
CHIEF FINANCIAL OFFICER BAKER, DONELSON, BEARMAN & CALDWELL, P.C.
CORNERSTONE BANCSHARES, INC. 207 MOCKINGBIRD LANE, SUITE 300
5319 HIGHWAY 153 JOHNSON CITY, TENNESSEE 37604
CHATTANOOGA, TENNESSEE 37343 (423) 928-0181
(423) 385-3000
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Approximate Date of Commencement of Proposed Sale to Public: AS SOON AS
PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [X]
If this form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, check the following box and list the
Securities Act Registration number of the earlier effective registration
statement for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
Registration number of the earlier effective registration statement for the same
offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
Registration number of the earlier effective registration statement for the same
offering. [ ]
If delivery of this prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
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CALCULATION OF REGISTRATION FEE
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PROPOSED PROPOSED
MAXIMUM MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING AGGREGATE REGISTRATION
SECURITIES TO BE REGISTERED REGISTERED (1) PRICE PER OFFERING PRICE(2) FEE
SHARE(2)
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Common Stock, $1.00 par value.................... 150,000 shares $13.00 $1,950,000 $515
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(1) Includes the maximum number of shares that may be issued in connection
with this offering.
(2) Estimated solely for the purpose of calculating the registration fee.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION ON SUCH DATE OR DATES AS MAY BE
NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER
AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL
THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES
ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH
DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(A), MAY DETERMINE.
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THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES, AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED February 4, 2000
PROSPECTUS
CORNERSTONE BANCSHARES, INC.
A MAXIMUM OF 150,000 SHARES
COMMON STOCK
We are initially offering up to 150,000 shares of our common stock, par
value $1.00 per share at a purchase price of $13.00 per share.
We may accept or reject any subscription for shares in whole or in part. If
we reject a subscription, we will return the full amount of the subscription
funds promptly to the subscriber.
There are no escrow arrangements with respect to funds received for
purchase of stock. Accordingly, subscription funds received and accepted will be
available for our immediate use.
Prior to this offering there has been no public market for our common
stock, and we do not anticipate that such a market will develop in the
foreseeable future. Our stock is not currently traded on any national securities
exchange, and we do not have any plan to arrange for our common stock to be
traded on any national securities exchange.
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. PLEASE SEE THE SECTION OF
THIS PROSPECTUS CALLED "RISK FACTORS," WHICH BEGINS ON PAGE ___, FOR A
DISCUSSION OF THE RISKS THAT YOU SHOULD CONSIDER BEFORE INVESTING IN OUR COMMON
STOCK.
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THE SECURITIES OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS OR DEPOSIT ACCOUNTS OF A
BANK OR SAVINGS ASSOCIATION AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE
CORPORATION OR ANY OTHER GOVERNMENT AGENCY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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PRICE TO PROCEEDS TO
PUBLIC CORNERSTONE
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Per Share ......... $13.00 $13.00 (1)
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Total............... $1,950,000 $1,915,000
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(1) Before deducting estimated offering expenses of $35,000 payable by
Cornerstone.
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___________________, 2000
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We have not authorized anyone to give you any information that differs from
the information in this prospectus. If you receive any different information,
you should not rely on it. We are offering to sell, and seeking offers to buy,
shares of our common stock only in jurisdictions where offers and sales are
permitted.
TABLE OF CONTENTS
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Prospectus Summary.......................................... 3
Risk Factors ............................................... 6
Cautionary Statements Regarding
Forward-Looking Information............................ 10
Use of Proceeds............................................. 11
Dividend Policy............................................. 11
Capitalization.............................................. 12
Dilution.................................................... 12
Selected Consolidated Financial Information................. 14
Management's Discussion and Analysis of
Financial Condition and Results of Operations.......... 15
Business.................................................... 24
Management.................................................. 39
Certain Transactions........................................ 41
Principal Shareholders...................................... 42
Description of Capital Stock................................ 43
Market for the Shares....................................... 45
Legal Matters............................................... 45
Experts..................................................... 45
Where You Can Find More Information......................... 45
Index to Consolidated Financial Statements.................. F-1
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PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus
and may not contain all of the information which is important to you. You should
read the entire prospectus, including the financial statements and related
notes, before making a decision to invest in our common stock. Throughout this
summary and the prospectus as a whole, we will use the terms "Cornerstone,"
"we," and "our" to refer to Cornerstone Bancshares, Inc. and its wholly-owned
subsidiary, Cornerstone Community Bank, unless the context indicates otherwise.
Unless we indicate otherwise, all share, per share and financial
information in this prospectus assumes a public offering price of $13.00 per
share and does not give effect to the use of proceeds of the offering.
CORNERSTONE BANCSHARES, INC.
Cornerstone Bancshares, Inc., 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,
resulted from the merger of The Bank of East Ridge and Cornerstone Community
Bank effective October 15, 1997. Cornerstone conducts its business as a
commercial bank, with special emphasis in retail banking, including the
acceptance of checking and saving 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.
OUR ADDRESS
Cornerstone's headquarters and principal banking office is located at
5319 Highway 153, Chattanooga, Tennessee. Our telephone number is (423)
385-3000.
THE OFFERING
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Common stock offered ................................ Up to 150,000 shares
Common stock to be outstanding after
the offering................................ 1,316,629 shares
Use of Proceeds...................................... The net proceeds will be used to support expansion
and diversification of operations, to support the
growth of Cornerstone Community Bank and for general
and investment purposes. For more information, see the
section called "Use of Proceeds."
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SUMMARY CONSOLIDATED FINANCIAL INFORMATION
The following tables set forth our summary financial information as of
and for the nine months ended September 30, 1999 and 1998, and as of and for
each of the two years ended December 31, 1998. This information is derived from
and should be read in conjunction with our historical financial statements,
including the notes to those statements, that appear elsewhere in this
prospectus. This information should also be read in conjunction with our
consolidated financial statements.
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For the nine months For the years ended
ended September 30, December 31,
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1999 1998 1998 1997
--------- --------- --------- --------
(In thousands, except per share data)
<S> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
Interest income ................. $ 5,685 $ 5,987 $ 8,212 $ 4,295
Interest expense ................ 2,741 3,175 4,231 2,154
Net interest income ............. 2,944 2,812 3,981 2,142
Provision for loan losses ....... 760 307 715 273
Noninterest income .............. 438 764 686 222
Noninterest expense ............. 3,291 2,592 3,551 1,722
Income before income taxes ...... (669) 678 400 368
Income tax expense .............. (151) 114 152 144
Net earnings (loss) ............. (518) 564 248 224
Basic earnings per share ........ $ (0.44) $ 0.56 $ 0.25 $ 0.35
Diluted earnings per share ...... $ (0.44) $ 0.54 $ 0.22 $ 0.28
Dividends per common share ...... $ -- $ -- $ -- $ --
Book value per common share ..... $ 9.97 $ 10.04 $ 10.16 $ 11.33
Average common shares outstanding 1,166 1,009 987 650
Fully diluted common shares ..... 1,306 1,159 1,137 800
SELECTED PERIOD-END BALANCES
Total assets .................... $ 102,666 $ 109,688 $ 110,506 $ 92,524
Earning assets .................. 92,039 96,642 100,686 80,836
Total securities ................ 19,851 20,991 18,358 18,324
Loans, net of unearned income ... 70,188 75,059 73,893 61,326
Allowance for loan losses ....... (985) (950) (1,400) (915)
Total deposits .................. 89,244 96,940 98,012 81,850
Long-term debt .................. -- 1,250 1,250 855
Redeemable common stock ......... 238 479 479 857
Stockholders' equity ............ 11,633 10,132 10,024 7,358
SELECTED AVERAGE BALANCES
Total assets .................... $ 102,558 $ 104,965 $ 105,763 $ 81,053
Earning assets .................. 91,584 91,161 92,930 73,487
Total securities ................ 22,662 24,319 20,269 19,207
Loans, net ...................... 68,922 66,842 69,356 50,120
Allowance for loan losses ....... (1,076) (861) (900) (706)
Total deposits .................. 89,799 92,064 93,206 72,135
Redeemable common stock ........ 279 479 479 146
Stockholders' equity ............ 10,351 10,039 9,799 6,118
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For the nine months For the years ended
ended September 30, December 31,
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1999 1998 1998 1997
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SELECTED RATIOS
Average loans to average deposits ....... 76.75% 72.60% 73.47% 69.48%
Allowance to year end loans (actual) n/a n/a 1.89% 1.49%
Equity to assets ........................ 11.33% 9.24% 9.07% 7.95%
Leverage capital ratio .................. 11.34% 9.65% 9.48% 9.08%
Return on assets ........................ -0.67% 0.72% 0.23% 0.28%
Return on equity ........................ -6.67% 7.49% 2.53% 3.66%
Dividend payout ratio ................... -- -- -- --
Net interest spread ..................... 3.73% 3.69% 3.79% 4.14%
Net interest margin ..................... 4.30% 4.12% 4.28% 4.80%
Average interest-earning assets to
average interest-bearing liabilities 114.11% 109.31% 110.74% 114.40%
Noninterest expense to average assets 3.21% 2.47% 3.36% 2.12%
Efficiency ratio ........................ 97.30% 72.46% 76.10% 72.85%
Net charge-offs to average loans ........ 1.70% 0.41% 0.33% 0.03%
Nonperforming assets to total assets 1.19% 0.05% 0.55% 0.00%
Nonperforming loans to total loans ...... 1.79% 1.00% 0.98% 0.23%
Allowance to total loans ................ 1.40% 1.27% 1.89% 1.49%
Allowance to total nonperforming
loans ............................. 78.29% 126.50% 193.64% 635.42%
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RISK FACTORS
You should review the following risk factors carefully, as well as the
other information contained in this prospectus, before you decide to invest in
our common stock.
WE OPERATED IN A DEFICIT DURING A PORTION OF OUR IMMEDIATELY PAST FISCAL YEAR.
IF WE OPERATE IN A DEFICIT IN THE FUTURE, THE VALUE OF OUR COMMON STOCK MAY
DECREASE.
Although we are currently profitable, we operated in a deficit during a
portion of our immediately past fiscal year. We cannot be certain that our
operations will remain profitable in the future. If our operations are not
profitable in the future, then the value of our common stock may decrease.
A DETERIORATION OF ECONOMIC CONDITIONS IN HAMILTON COUNTY, TENNESSEE COULD
ADVERSELY AFFECT OUR OPERATIONS.
Our banks are located and concentrated in Hamilton County in East
Tennessee. As a result of this geographic concentration, our results depend
largely upon economic conditions in this area. A deterioration in economic
conditions could have a significant, adverse impact on the quality of our loan
portfolios and the demand for our products and services, and therefore upon our
results of operations. See the section called "Business" for more information
about this issue.
WE RISK LOSING CUSTOMERS BECAUSE WE FACE SIGNIFICANT COMPETITION IN ALL ASPECTS
OF OUR OPERATIONS.
The banking and financial services business in East Tennessee
generally, and in our market area specifically, is highly competitive. As of
September 30, 1999, we had 2% of the market share in Hamilton County, which is
our primary market. The competitive environment is primarily a result of changes
in regulation, changes in technology and product delivery systems and the
accelerating pace of consolidation among financial service providers. We compete
for loans, deposits and customers and the delivery of other financial services
with other commercial banks, savings and loan associations, securities and
brokerage companies, mortgage companies, insurance companies, finance companies,
money market funds, credit unions, and other non-bank financial service
providers. Many of these competitors have much greater total assets and
capitalization, and have greater access to capital markets and offer a broader
array of financial services than we do. There can be no assurance that we will
be able to compete effectively. Our results of operations could be adversely
affected as circumstances affecting the nature or level of competition change.
See the section called "Business" for more information about this issue.
WE DEPEND UPON THE CONTRIBUTION OF OUR KEY OFFICERS, AND OUR BUSINESS AND
FINANCIAL CONDITION COULD BE MATERIALLY ADVERSELY AFFECTED IF ANY OF THEM
DEPARTS.
Our success will depend substantially upon our senior officers, Gregory
B. Jones, Nathaniel F. Hughes and Jerry D. Lee in particular. Our business and
financial condition could be materially adversely affected if we lose the
services of any of these persons. We have employment contracts with all of these
officers, but do not carry key man insurance on the lives of any of our
officers. See the section called "Management" for more information about our
officers.
UNEXPECTED LOSSES IN OUR CREDIT PORTFOLIO COULD ADVERSELY AFFECT OUR OPERATIONS.
A significant source of risk arises from the possibility that we will
sustain losses because borrowers, guarantors and related parties fail to perform
in accordance with the terms of their loans. We have adopted underwriting and
credit monitoring procedures and credit policies, including the establishment
and review of the allowance for credit losses, that management believes are
appropriate to minimize this risk. These policies assess the likelihood of
nonperformance, track loan performance and diversify our credit portfolio. Such
policies and procedures, however, may not prevent unexpected losses that could
materially adversely affect our results of
6
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operations. More information about this issue is available in the sections
called "Business - Loan Portfolio," "Business - Loan Policy" and "Business -
Credit Risk Management and Reserve for Loan Losses."
A significant portion of our business involves commercial business and
commercial real estate loans to small businesses. We attempt to collateralize
all of our commercial loans with real estate or tangible commercial assets, but
these types of loans nonetheless involve certain risks. Repayment of a loan
secured by commercial real estate properties often depends upon the successful
operation or management of the properties. The repayment of a commercial loan
typically depends upon the successful operation and income stream of the
borrower. The repayment of these loans may therefore be more difficult during
adverse conditions in the real estate market or the economy. Further, commercial
and commercial real estate loans may also involve relatively large loan balances
to single borrowers or groups of related borrowers.
CORNERSTONE COMMUNITY BANK IS OPERATING UNDER A MEMORANDUM OF UNDERSTANDING WITH
ITS REGULATORS; CONFORMING TO THE REQUIREMENTS OF THE MEMORANDUM MAY RESTRICT
THE FLEXIBILITY OF OUR OPERATIONS AND MATERIALLY ADVERSELY AFFECT THE RESULTS OF
OUR OPERATIONS.
Cornerstone Community Bank is operating under a Memorandum of
Understanding with the Tennessee Department of Financial Institutions and the
Federal Deposit Insurance Corporation. Among other things, the Memorandum
provides the following:
- The Board of Directors must develop a written management plan
that addresses Cornerstone Community Bank's plans for size,
structure, growth, earnings, services, information systems,
personnel, accounting, financial reporting and operating
matters;
- Cornerstone Community Bank must maintain a Tier I leverage
capital ratio of equal to or greater than 8%;
- Cornerstone Community Bank may not pay dividends without the
prior approval of the FDIC; and
- Cornerstone Community Bank must report its progress on the
actions required by the Memorandum to the FDIC on specific
dates.
At September 30, 1999, Cornerstone Community Bank reported to the FDIC
that it was in compliance with all provisions of the Memorandum. However,
because of the increased regulatory scrutiny required by the Memorandum, the
activities of Cornerstone Community Bank and Cornerstone are more restricted,
and these restrictions may affect the flexibility of Cornerstone in conducting
its business operations.
YOUR INTERESTS AS AN INVESTOR IN CORNERSTONE MAY DIFFER FROM THE INTERESTS OF
OUR OFFICERS AND DIRECTORS, WHO HOLD A SIGNIFICANT PORTION OF THE VOTING POWER
OF OUR COMMON STOCK AND CAN SIGNIFICANTLY INFLUENCE MATTERS UPON WHICH THE
SHAREHOLDERS VOTE.
Prior to the offering, our directors and executive officers together
have the power to vote 39.0% of our outstanding shares of common stock.
Following the offering assuming the maximum number of shares is sold and
assuming none of our directors or executive officers purchases any additional
shares in the offering, they will together have the power to vote 34.7% of our
outstanding shares of common stock.
Our directors and executive officers, as a group, will have the ability
to influence significantly the outcome of all matters requiring a shareholder
vote, including the election of directors, adopting or amending provisions of
our Charter and approving certain mergers or other similar transactions, such as
the sale of substantially all of our assets. More information about this issue
is presented in the sections called "Management" and "Principal Shareholders."
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WE ARE SUBJECT TO REGULATION BY MANY AGENCIES, AND THIS REGULATION MAY ADVERSELY
AFFECT OUR ABILITY TO CONDUCT BUSINESS.
We are subject to extensive regulation, supervision and examination by
the Tennessee Department of Financial Institutions, the Federal Deposit
Insurance Corporation, the Securities and Exchange Commission, and the Federal
Reserve Board. The regulatory restrictions require minimal capital ratios, and
limit and regulate the businesses in which we may engage. Our business is also
subject to other extensive regulation, such as that applicable to various types
of consumer lending, violations of which may result in significant penalties and
damages. While we are "well capitalized" for regulatory purposes, we are
currently operating in a deficit. Further, we have experienced capital
deficiencies in the past and there can be no assurance our performance or the
regulatory environment will not change in a materially adverse way. See the
section called "Business - Supervision and Regulation" for more information
about this issue.
CHANGES IN INTEREST RATES MAY SIGNIFICANTLY DECREASE OUR NET INCOME AND, THUS,
OUR PROFITABILITY.
Our operations are materially affected by general economic conditions,
the monetary and fiscal policies of the federal government, regulatory policies
of governmental authorities and other factors that affect market rates of
interest. These factors are beyond our control. Our results of operations depend
to a large extent on our "net interest income," which is the difference between
interest income on interest-earning assets, such as loans and investments, and
interest expense on interest-bearing liabilities, such as deposits and
borrowings. More information about this issue is presented in the section called
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
BECAUSE THERE IS NO PUBLIC MARKET FOR OUR COMMON STOCK, AND WE DO NOT ANTICIPATE
THAT A PUBLIC MARKET WILL DEVELOP IN THE FORESEEABLE FUTURE, YOU MAY NOT BE ABLE
TO SELL YOUR STOCK.
Prior to this offering, there has been no public market for our common
stock. We do not anticipate that an active public trading market our common
stock will develop or be maintained in the foreseeable future. The public
offering price has been determined by Cornerstone and may not indicate the
market price after the offering. The future price of the common stock will be
determined by the market. Purchasers of our common stock should have a long-term
investment intent and recognize that the absence of an active and liquid trading
market may make it difficult to sell the common stock and may have an adverse
effect on the price.
PURCHASERS OF THE COMMON STOCK IN THIS OFFERING WILL EXPERIENCE AN IMMEDIATE AND
SUBSTANTIAL DILUTION OF THEIR SHARES. IF ADDITIONAL COMMON STOCK IS ISSUED IN
THE FUTURE, THE SHARES PURCHASED IN THIS OFFERING WILL BE FURTHER DILUTED.
Purchasers of common stock in this offering will experience an
immediate and substantial dilution of $4.80 per share in the net tangible book
value of their shares of common stock immediately following this offering.
Current shareholders will receive a material increase in the book value of their
shares. If we issue additional common stock in the future, including shares that
may be issued in connection with acquisitions, purchasers of common stock in
this offering may experience further dilution in net tangible book value per
share of the common stock. The section called "Dilution" provides additional
information about this issue.
THERE CAN BE NO ASSURANCE THAT ANY OF THE USES FOR THE PROCEEDS OF THIS OFFERING
WILL GENERATE A PROFITABLE RETURN FOR CORNERSTONE.
We have no specific use designated for the proceeds we will receive
from this offering. The eventual use of proceeds will be determined from time to
time by our Board of Directors and senior management. There can be no assurance
that any of the uses to which offering proceeds may be applied will generate a
profitable return. More information may be found in the section called "Use of
Proceeds."
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WE DO NOT PLAN TO PAY ANY CASH DIVIDENDS ON OUR COMMON STOCK IN THE FORESEEABLE
FUTURE.
We have not paid a cash dividend on our common stock and we have no
plan to do so in the foreseeable future. Our ability to pay dividends is
restricted by federal laws and regulations applicable to bank holding companies,
and by Tennessee laws relating to the payment of dividends by Tennessee
corporations. Because substantially all of our operations are conducted through
our subsidiaries, our ability to pay dividends depends on the ability of our
subsidiaries to pay dividends to it. The ability of Cornerstone Community Bank
to pay dividends is restricted by the Memorandum of Understanding issued by our
regulators in November 1998. As a result, we may not be able to declare a
dividend to holders of the common stock even if our present dividend policy were
to change. See "Dividend Policy" for additional information on this subject.
BANKING REFORM LEGISLATION MAY INCREASE COMPETITION, AND WE MAY THEREFORE FIND
IT MORE DIFFICULT TO COMPETE.
On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Financial Services Modernization Act of 1999, federal
legislation intended to modernize the financial services industry by
establishing a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms and other financial service
providers. As a result of the legislation, bank holding companies will be
permitted to engage in a wider variety of financial activities than permitted
under prior law, particularly with respect to insurance and securities
activities. In addition, in a change from prior law, bank holding companies will
be in a position to be owned, controlled or acquired by any company engaged in
financially-related activities. However, to the extent that it permits banks,
securities firms and insurance companies to affiliate, the financial services
industry may experience further consolidation. This could result in a growing
number of larger financial institutions that offer a wider variety of financial
services than we currently offer and that can aggressively compete in the
markets we currently serve. These developments could adversely impact our
profitability.
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CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION
This prospectus includes forward-looking statements. We have based
these forward-looking statements on our current expectations and projections
about future events. These forward-looking statements are subject to risks,
uncertainties and assumptions, including, among other things:
- adverse changes in our loan and lease portfolios and the
resulting credit risk-related losses and expenses;
- adverse changes in the economy of the East Tennessee region,
our primary market, that could further increase credit-related
losses and expenses;
- adverse changes in the East Tennessee real estate market that
could also negatively affect credit risk, as most of our
commercial loans are made to borrowers concentrated in East
Tennessee and a substantial portion of those loans have real
estate as primary or secondary collateral;
- the consequences of continued bank acquisitions and mergers in
our market, resulting in fewer but much larger and financially
stronger competitors, which could increase competition for
financial services to our detriment;
- fluctuations in market rates and prices, which could
negatively affect our net interest margin, asset valuations
and expense expectations; and
- changes in regulatory requirements of federal and state
agencies applicable to bank holding companies and banks such
as Cornerstone and Cornerstone Community Bank.
We undertake no obligation to update publicly or otherwise revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. In light of these risks, uncertainties and assumptions, the
forward-looking events discussed in this prospectus might not occur.
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USE OF PROCEEDS
The net proceeds to us from this offering are estimated to be
approximately $1.915 million after deduction of the estimated expenses. We
intend to use approximately 25% of the funds to support future expansion of
operations or diversification into other banking-related businesses and for
other business or investment purposes, although we have not identified any
specific acquisition, expansion, diversification or investment opportunities.
The remainder of the funds may be transferred to Cornerstone Community Bank and
used for its general corporate purposes, including the origination of loans,
funding the construction and/or the acquisition costs of establishing new branch
locations, enhancing its liquidity ratios and enhancing future access to capital
markets. It is expected that until needed for other purposes, all or part of the
net proceeds retained by us will be invested through our investment program or
used to reduce borrowings from other financial institutions.
DIVIDEND POLICY
Cornerstone's board of directors does not intend to pay cash dividends
on our common stock in the foreseeable future. Future declaration and payment of
dividends, whether cash or stock, if any, will be determined in light of the
then current conditions, including our earnings, operations, capital
requirements, financial condition, restrictions in financing agreements and
other factors deemed relevant by the board. Our ability to pay dividends is
restricted by federal laws and regulations applicable to bank holding companies,
and by Tennessee laws relating to the payment of dividends by Tennessee
corporations. Because substantially all of our operations are conducted through
Cornerstone Community Bank, our ability to pay dividends also depends on its
ability to pay dividends to us. The Memorandum of Understanding issued by our
regulators in November 1998 prohibits Cornerstone Community Bank's payment of
dividends to Cornerstone without the prior written consent of the FDIC. As a
result, we may not be able to declare a dividend to holders of the common stock
even if our present dividend policy were to change. See "Business - Supervision
and Regulation" for more information regarding the restrictions under which we
operate.
11
<PAGE> 13
CAPITALIZATION
The following table sets forth our capitalization as of September 30,
1999 and our capitalization as of that date after giving effect to the sale of
the maximum number of shares of common stock in this offering and the
application of the estimated net proceeds from the sale of 150,000 shares of
common stock (which we estimate will be $1.915 million). The information set
forth below should be read in conjunction with the financial information
included elsewhere in this prospectus.
<TABLE>
<CAPTION>
September 30, 1999
---------------------------------------
Actual As Adjusted
-------- -----------
(In thousands)
<S> <C> <C>
Redeemable common stock $ 238 $ 238
Stockholders' equity:
Preferred stock, no par value, 2,000,000 shares -- --
authorized; no shares issued
Common Stock, $1.00 par value; 2,000,000 authorized
shares; 1,166,329 shares outstanding prior to the
offering; and 1,316,329 shares to be outstanding after
the offering (1).................................................. 1,166 1,316
Additional paid-in capital.......................................... 11,125 13,040
Retained earnings (deficit)......................................... (42) (42)
Accumulated other comprehensive income.............................. (518) (518)
Unrealized gain (loss) on available-for-sale securities............. (98) (98)
-------- --------
Total stockholders' equity ....................................... 11,633 13,698
-------- --------
Total capitalization ............................................. $ 11,633 $ 13,698
======== ========
</TABLE>
- ----------------------
(1) Assumes 150,000 shares of common stock sold in this offering.
DILUTION
The net tangible book value of Cornerstone as of September 30, 1999,
was approximately $8.88 million, or $7.62 per share. Net tangible book value
represents the amount by which our total tangible assets exceeded our total
liabilities. The calculation of net tangible book value on a per share basis is
equal to net tangible book value divided by the aggregate number of shares of
common stock outstanding. After giving effect to the sale of the 150,000 shares
of common stock offered, at an assumed public offering price of $13 per share,
and the application of the net proceeds as described in "Use of Proceeds," our
pro forma net tangible book value as of September 30, 1999 would have been
approximately $10.8 million, or $8.20 per share. This represents an immediate
increase in net tangible book value of $0.58 per share to existing shareholders
and an immediate dilution of $4.80 per share to persons purchasing common stock
in this offering. The following table illustrates this per share dilution, after
deduction of underwriting discounts and offering expenses:
<TABLE>
<S> <C> <C>
Price to Public per share............................................... $13.00
Net tangible book value per share before offering..................... $7.62
Increase per share attributable to the sale of shares offered ........ 0.58
Pro forma net tangible book value per share after offering.............. 8.20
------
Dilution in pro forma net tangible book value per share
to new investors.................................................... $ 4.80
======
</TABLE>
12
<PAGE> 14
The following table sets forth, on a pro forma as adjusted basis as of
September 30,1999, the differences between the existing shareholders and the new
investors with respect to the number of shares purchased from Cornerstone, the
total consideration paid and the average price per share paid.
<TABLE>
<CAPTION>
(Dollars in thousands except Shares Purchased Total Contribution
share data)
-----------------------------------------------------------------------------
Number Percent Amount Percent Per Share
------ ------- ------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing shareholders 1,166 88.60% $ 8,883 82.26% $ 7.62
New shareholders 150 11.40% $ 1,915 17.74% $ 13.00
----- ------ ------- ------
Total 1,316 100.00% $10,798 100.00%
===== ====== ======= ======
</TABLE>
13
<PAGE> 15
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following tables set forth our summary financial information as of
and for the nine months ended September 30, 1999 and 1998, and as of and for
each of the two years ended December 31, 1998. This information is derived from
and should be read in conjunction with our historical financial statements,
including the notes to those statements, that appear elsewhere in this
prospectus, and also with our consolidated condensed financial statements.
<TABLE>
<CAPTION>
For the nine months For the years ended
ended September 30, December 31,
------------------------- ------------------------
1999 1998 1998 1997
--------- --------- -------- --------
(In thousands, except per share data)
<S> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
Interest income ........................ $ 5,685 $ 5,987 $ 8,212 $ 4,295
Interest expense ....................... 2,741 3,175 4,231 2,154
Net interest income .................... 2,944 2,812 3,981 2,142
Provision for loan losses .............. 760 307 715 273
Noninterest income ..................... 438 764 686 222
Noninterest expense .................... 3,291 2,592 3,551 1,722
Income before income taxes ............. (669) 678 400 368
Income tax expense ..................... (151) 114 152 144
Net earnings (loss) .................... (518) 564 248 224
Basic earnings per share ............... $ (0.44) $ 0.56 $ 0.25 $ 0.35
Diluted earnings per share ............. $ (0.44) $ 0.54 $ 0.22 $ 0.28
Dividends per common share ............. $ -- $ -- $ -- $ --
Book value per common share ............ $ 9.97 $ 10.04 $ 10.16 $ 11.33
Average common shares outstanding ...... 1,166 1,009 987 650
Fully diluted common shares ............ 1,306 1,159 1,137 800
SELECTED PERIOD-END BALANCES
Total assets ........................... $ 102,666 $ 109,688 $ 110,506 $ 92,524
Earning assets ......................... 92,039 96,642 100,686 80,836
Total securities ....................... 19,851 20,991 18,358 18,324
Loans, net of unearned income .......... 70,188 75,059 73,893 61,326
Allowance for loan losses .............. (985) (950) (1,400) (915)
Total deposits ......................... 89,244 96,940 98,012 81,850
Long-term debt ......................... -- 1,250 1,250 855
Redeemable common stock ................ 238 479 479 857
Stockholders' equity ................... 11,633 10,132 10,024 7,358
</TABLE>
14
<PAGE> 16
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 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, 1997. 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.
RESULTS OF OPERATIONS - QUARTER ENDED SEPTEMBER 30, 1999 COMPARED TO QUARTER
ENDED SEPTEMBER 30, 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 third three months of 1999 increased
$81,138 or 8.0% above net interest income earned as of September 1998. The
increase in net interest income as of September 30, 1999 is primarily due to an
increase in Cornerstone's net interest margin on earning assets, which rose from
4.14% to 4.76% in 1999, and a smaller provision to loan loss. The increased
margin was a result of management's efforts to change the deposit mix from
certificate of deposit to a transaction account deposit base. The strategic
direction has produced material improvements in the net interest margin and
should continue to assist the Cornerstone's earnings in the future. The lower
provision represents an improvement in the loan portfolio's quality, but
reflects no future direction.
Interest income decreased $140,337 or 6.7% as of September 1999
compared to September 1998. Interest income produced by the loan portfolio
decreased $123,209 or 7.0% from September 1998 to September 1999 due to the
decrease in average loans outstanding for the period. Management estimates the
average balances will increase, but will restrain origination of these loans to
insure quality standards and documentation are maintained. Interest income on
investment securities and federal funds decreased $17,128 or 4.8% from September
1998 to September 1999, due primarily to reduced deposit balances and the
purchase of lower yielding securities which reduced the Bank's interest rate
risk and gave Cornerstone a more predictable cash-flow.
Total interest expense decreased $221,474 or 20.11% from September 30,
1998 to September 30, 1999. The interest expense decrease from the third quarter
of 1998 to the third quarter of 1999 is primarily due to the active management
of the ALCO committee to reduce certificate of deposit exposure and lower
general rates to the market norm while the loan portfolio review slowed funding
needs.
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 September 30, 1999 was 4.76%. The yield on
earning assets decreased 5 basis points to 8.64% at September 30, 1999 from
8.69% at September 30, 1998.
15
<PAGE> 17
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 and third quarter 1999, the interest rate spread was 4.14%, an increase of
58 basis points from September 1998 to September 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 $985,234 for
September 1999 in the allowance for loan loss account reflects the full known
extent of credit exposure. This amount includes a provision of $105,000 made in
the third quarter of 1999. The Bank anticipates similar provisions in the future
as the loan portfolio grows and unanticipated loan losses occur. 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 September 30, 1999 Cornerstone had
$919,270 in non-accrual loans and $1.2 million 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. Total non-interest income decreased by $45,892 or 28.5%
from September 1998 to September 1999.
Non-interest Expense.
Non-interest expense for the third three months of 1999 increased by
$184,936 or 20.4% as compared to the third three months in 1998. Salaries and
employee benefits increased by $137,718 or 32.0% in September 1999 over
September 1998. Occupancy expense as of September 30, 1999 increased by $35,215
or 35.2% over the same period in 1998. All other non-interest expenses at June
30, 1999 increased $12,064 or 3.2% over the non-interest expenses as of
September 30, 1998.
RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE
MONTHS ENDED SEPTEMBER 30, 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.
16
<PAGE> 18
Net interest income for the first nine months of 1999 increased
$131,714 or 4.7% above net interest income earned as of September 1998. The
increase in net interest income as of September 30, 1999 is primarily due to an
increase in the Bank's net interest margin on earning assets, which rose from
4.12% to 4.3% in 1999. Reduced deposit costs caused by a change in the deposit
mix from certificates of deposits to transaction accounts contributed the
majority of the net interest margin increase.
Interest income decreased $302,611 or 5.1% as of September 1999
compared to September 1998. Interest income produced by the loan portfolio
decreased $135,740 or 2.8% from September 1998 to September 1999 due to the
decrease in average yields for the period. Two factors contributed to the
reduction of loan yields. In the first half of the year a review of all loans
placed many loans on non-accrual and previously booked interest income was
reversed. In addition, during this period of corrective actions loan
originations paused and loan fee income was greatly reduced. Interest income on
investment securities and federal funds decreased $166,871 or 14.4% from
September 1998 to September 1999, due primarily to reduced deposit balances.
Total interest expense decreased $434,324 or 13.7% from September 30,
1998 to September 30, 1999. The interest expense decrease is primarily due to
the active management of the ALCO committee to reduce certificate of deposit
exposure and lower general rates to the market norm while the loan portfolio
review slowed funding needs.
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 September 30, 1999 was 4.30%. The yield on
earning assets decreased 48 basis points to 8.30% at September 30, 1999 from
8.78% at September 30, 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 non-interest 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 and 1999, the interest rate spread was 3.73%, a increase of 4 basis points
from September 1998 to September 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 $985,234 for
September 1999 in the allowance for loan loss account reflects the full known
extent of credit exposure. 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 September 30, 1999 Cornerstone had
$919,270 in non-accrual loans and $1.26 in non-performing loans.
17
<PAGE> 19
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. Total non-interest income decreased by $326,103 or 46.6%
from September 1998 to September 1999.
Non-interest Expense.
Non-interest expense for the first nine months of 1999 increased by
$699,281 or 27.0% as compared to the first nine months in 1998. Salaries and
employee benefits increased by $350,324 or 27.9% in September 1999 over
September 1998. Occupancy expense as of September 30, 1999 increased by $72,300
or 18.2% over the same period in 1998. All other non-interest expenses at
September 30, 1999 increased $276,658 or 27.4% over the non-interest expenses as
of September 30, 1998, primarily due to an increase in professional fees, and
miscellaneous charge-offs.
FOR THE YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR ENDED DECEMBER 31,
1997
SUMMARY
Net income for 1998 was $248,332, a 10.81% increase from Cornerstone's
net income of $224,100 in 1997. Net income per common share for 1998 was 28.6%
lower than in 1997. Pretax income for 1998 increased $31,854 from 1997 pretax
income of $368,434.
The decrease in net income per share from 1997 to 1998 is primarily due
to a 162% increase in the loan loss provision and high interest expense paid on
core deposits and jumbo (over $100m) certificates of deposit.
FINANCIAL CONDITION
Earning Assets.
Average earning assets in 1998 increased $19.4 million or 26.4% over
1997 primarily due to an increase in average loans outstanding. The loan growth
was primarily funded by a significant increase in time deposits.
Loan Portfolio.
Cornerstone's average loans for 1998 were $69 million, an increase of
38% over $50 million in average loans for 1997. Loan growth for 1998 was
primarily funded through increased deposit growth. Real estate loans increased
by $10.0 million or 24% and commercial loans increased by $1.0 million or 8%
over 1997. The increase in ending balances from 1997 to 1998 was consistent with
the increase in average balances.
Investment Portfolio.
Cornerstone's investment securities portfolio increased by 5% or $1.0
million from 1997 to 1998. 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 1998, unrealized gains in the "Available for
Sale" portfolio amounted to $63,050.
18
<PAGE> 20
Deposits.
Cornerstone's average deposits increased $22.3 million or 31% from 1997
to 1998. From year end 1997 to year end 1998, total deposits increased $16.2
million or 20%. The largest portion of growth during 1998 was an $11.2 million,
or 23% increase in time deposits. This is due to Cornerstone's strategy of
increasing time deposits by offering competitive rates to customers.
Capital Resources.
Stockholders' equity increased $1.8 million or 22% to $10.0 million as
of December 31, 1998, compared with $8.2 million at the end of 1997. 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
December 31, 1998, Cornerstone had approximately $5.0 million of federal funds
lines available.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR
ENDED DECEMBER 31, 1997
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 1998 increased $1.4 million or 75% over 1997.
The increase in the net interest income from 1997 to 1998 is primarily due to
the increase in interest-earning assets.
Interest income increased $3.96 million or 92% in 1998 from 1997.
Interest income produced by the loan portfolio increased $3.37 million or 99% in
1998 from 1997. Interest income on investment securities increased $587,000 or
66% from 1997 to 1998. The increase in investment income is due to an increase
in the average investment securities portfolio during 1998.
Total interest expense increased $2.1 million or 98% in 1998 from 1997.
The interest expense increase from 1997 to 1998 is primarily due to the increase
in average time deposits.
19
<PAGE> 21
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 decreased 52 basis points in 1998 to 4.28%. The
net cost of funds, defined as interest expense divided by average-earning
assets, decreased 9 basis points from 4.09% in 1997 to 4.00% in 1998. The yield
on earning assets decreased 47 basis points to 8.83% in 1998 from 9.30% in 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 $1.4 million for
December 1998 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, 1998, Cornerstone had $723,000
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
increased by $464,000 or 208% from 1997 to 1998. Fee income from service charges
on deposit accounts increased $270,000 or 137% in 1998 accounting for a larger
portion of the total noninterest income increase for the year.
Noninterest Expense.
Noninterest expense for 1998 increased by $1.8 million or 106% from
1997. Salaries and employee benefits increased by $741,000 or 80% from 1997 for
a total of $1.7 million. This increase was due to the East Ridge Bank
Acquisition in 1997. Occupancy expense increased by $116,000 or 106% in 1998
which is attributed to the additional expense adding the East Ridge Branch
located on Ringgold Road 1997. All other noninterest expense increased $971,000
or 142% in 1998, primarily the result of Cornerstone's legal expenses and other
professional expense relating to the loan portfolio in 1998.
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,
20
<PAGE> 22
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 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:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
----------------- -----------------
<S> <C> <C>
Average loans to average deposits 74.41% 69.48%
</TABLE>
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
21
<PAGE> 23
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.
<TABLE>
<CAPTION>
(Dollars in thousands) December 31, 1998 December 31, 1997
----------------- -----------------
<S> <C> <C>
CAPITAL:
Tier I capital:
Stockholders' equity................................ $ 10,024 $ 8,215
Less disallowed intangibles ........................ 2,878 2,906
-------- -------
Total Tier I capital....................... 7,151 5,309
Tier II capital:
Qualifying debt...................................... -- --
Qualifying allowance for loan losses................ 1,381 915
-------- -------
Total Tier II capital ...................... 8,532 6,224
-------- -------
Total capital............................... $ 8,532 $ 6,224
======== =======
Risk-adjusted assets.......................................... $ 79,598 $69,832
Quarterly average assets...................................... $105,286 $82,957
RATIOS:
Tier I capital to risk-adjusted assets........................ 8.98% 7.60%
Tier II capital to risk-adjusted assets....................... 10.72% 8.91%
Leverage -- Tier I capital to quarterly average assets less
disallowed intangibles........................................ 6.98% 6.63%
</TABLE>
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.
<TABLE>
<CAPTION>
Total Risk-Based Tier I Risk-Based Leverage
Capital Ratio Capital Ratio Ratio
---------------- ----------------- ------------
<S> <C> <C> <C>
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
</TABLE>
On December 31, 1998, Cornerstone exceeded the regulatory minimums and
qualified as a well-capitalized institution under the regulations.
NEW ACCOUNTING AND REPORTING REQUIREMENTS
New accounting and reporting pronouncements and guidance from the
Securities and Exchange Commission, federal banking regulators, the American
Institute of Certified Public Accountants, the Financial Accounting Standards
Board, or Congress that are required to be implemented by public reporting
companies are not applicable to Cornerstone's current operations. Proposed
accounting and reporting pronouncements and guidance from the Securities and
Exchange Commission, federal banking regulators, the American Institute of
Certified Public Accountants, the Financial Accounting Standards Board, or
Congress include possible changes to the guidance on the methodology used in
determining the adequacy of the allowance for loan losses. Any changes to the
guidance on the methodology used in determining the adequacy of the allowance
for loan losses is not expected to affect the current or the expected future
operations of Cornerstone. Other proposed accounting and reporting
pronouncements and guidance from the Securities and Exchange Commission, federal
banking
22
<PAGE> 24
regulators, the American Institute of Certified Public Accountants, the
Financial Accounting Standards Board, or Congress are not applicable to
Cornerstone's current or the expected future operations.
23
<PAGE> 25
BUSINESS
GENERAL
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, 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 Albertson's Supermarkets. Cornerstone
conducts its business as a commercial bank, with special emphasis in retail
banking, including the acceptance of checking and saving 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 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, 1997. 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 September 30, 1999, Cornerstone had 57 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 our service
area. As of September 30, 1999, we had 2% of the market share in Hamilton
County, Tennessee, which is our primary market.
SUPERVISION AND REGULATION
Cornerstone is a bank holding company within the meaning of the Federal
Bank Holding Company Act of 1956, as amended, and is registered with the Board
of Governors of the Federal Reserve System. Cornerstone is required to file with
the Federal Reserve Board annual reports and such additional information as the
Federal Reserve Board may require pursuant to the Act. The Federal Reserve 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 Federal Reserve 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
24
<PAGE> 26
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 Federal Reserve
Board has determined to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto. The Gramm-Leach-Bliley
Financial Modernization Act of 1999, enacted on November 12, 1999, broadens the
ability of a bank holding company to own or control companies other than banks.
See "Recent Developments."
Effective September 29, 1995, the Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "Riegle-Neal Act") allows the Federal
Reserve Board to approve an application of an adequately capitalized and
adequately managed bank holding company to acquire control of, or acquire all or
substantially all of the assets of, a bank located in a state other than such
holding company's home state, without regard to whether the transaction is
prohibited by the laws of any state. The Federal Reserve Board may not approve
the acquisition of bank that has not been in existence for the minimum time
period (not exceeding five years) specified by the statutory law of the host
state. The Riegle-Neal Act also prohibits the Federal Reserve Board from
approving an application if the applicant (and its depository institution
affiliates) controls or would control more than 10% of the insured deposits in
the United States or 30% or more of the deposits in the target bank's home state
or in any state in which the target bank maintains a branch. The Riegle-Neal Act
does not affect the authority of states to limit the percentage of total insured
deposits in the state which may be held or controlled by a bank or bank holding
company to the extent such limitation does not discriminate against out-of-state
banks or bank holding companies. Individual states may also waive the 30%
state-wide concentration limit contained in the Riegle-Neal Act.
Additionally, the federal banking agencies are authorized to approve
interstate merger transactions without regard to whether such transaction is
prohibited by the law of any state, unless the home state of one of the banks
has opted out of the Riegle-Neal Act by adopting a law after the date of
enactment of the Riegle-Neal Act and prior to June 1, 1997 which applies equally
to all out-of-state banks and expressly prohibits merger transactions involving
out-of-state banks. Interstate acquisitions of branches are permitted only if
the law of the state in which the branch is located permits such acquisitions.
Interstate mergers and branch acquisitions are also subject to the nationwide
and statewide insured deposit concentration amounts described above.
The Riegle-Neal Act authorizes the FDIC to approve interstate branching
de novo by national and state banks, respectively, only in states which
specifically allow for such branching. The Riegle-Neal Act also requires the
appropriate federal banking agencies to prescribe regulations which prohibit any
out-of-state bank from using the interstate branching authority primarily for
the purpose of deposit production.
Cornerstone Community 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
25
<PAGE> 27
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.
Cornerstone Community Bank is a member of the FDIC and is subject to
examination and regulation by that authority. Cornerstone Community Bank is
chartered under the banking laws of the State of Tennessee and is subject to the
supervision of, and regular examination by, the Tennessee Department of
Financial Institutions.
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. Cornerstone Community 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.
RECENT DEVELOPMENTS
The Gramm-Leach-Bliley Financial Modernization Act of 1999 permits bank
holding companies meeting certain management, capital, and community
reinvestment act standards to engage in a substantially broader range of
non-banking activities than permitted previously, including insurance
underwriting and merchant banking activities. The Act repeals sections 20 and 32
of the Glass Steagall Act, permitting affiliations of banks with securities
firms and registered investment companies. The Act authorizes financial holding
companies, permitting banks to be owned by security firms, insurance companies
and merchant banking companies and visa-versa. Some of these affiliations are
also permissible for bank subsidiaries. The Act gives the Federal Reserve Board
authority to regulate financial holding companies, but provides for functional
regulation of subsidiary activities.
The Gramm-Leach-Bliley Financial Modernization Act also modifies
financial privacy and community reinvestment laws. The new financial privacy
provisions generally prohibit financial institutions such as the company from
disclosing non-public personal financial information to third parties unless
customers have the opportunity to opt out of the disclosure. The Act also
magnifies the consequences of a bank receiving a less than a satisfactory
community reinvestment act rating, by freezing new activities until the
institution achieves a better community reinvestment act rating.
26
<PAGE> 28
EFFECT OF GOVERNMENTAL POLICIES
Cornerstone and Cornerstone Community 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.
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 Cornerstone
Community 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.
27
<PAGE> 29
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 nine months ended September 30, 1999 and
1998 and the years ended December 31, 1998 and 1997.
<TABLE>
<CAPTION>
September 30,
----------------------------------------------------------
1999 1998
------------------------------------------------------------
(Fully taxable equivalent) Interest Average Interest Average
(Dollars in thousands) Average Income/ Yields/ Average Income/ Yields/
Balance Expense Rate Balance Expense Balance
------- -------- ------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning assets:
Loans, net of unearned income....... $ 68,922 $ 4,690 9.10% $ 66,842 $ 4,825 9.65%
Investment securities .............. 18,285 834 6.10% 20,542 1,007 6.56%
Federal funds sold ................. 4,377 161 4.93% 3,777 155 5.47%
Other earning assets ............... -- --
-------- --------
Total earning assets............ 91,584 5,685 8.30% 91,161 5,987 8.78%
Allowance for loan losses........... (1,076) (861)
Cash and other assets............... 12,050 14,665
-------- --------
Total........................... $102,558 $104,965
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Demand deposits..................... $ 13,530 $ 172 1.70% $ 12,123 $ 195 2.15%
Savings deposits.................... 9,760 237 3.25% 10,439 294 3.76%
Time certificates................... 39,805 1,593 5.35% 45,272 1,893 5.59%
Time deposits of $100,000 or more... 15,846 660 5.57% 14,520 730 6.72%
Federal funds and securities
sold under agreement to
repurchase.................... 318 11 4.75% -- -- 0.00%
Other borrowings ................... 999 67 8.98% 1,046 63 8.08%
-------- ------- -------- --------
Total interest-bearing liabilities 80,258 2,741 4.57% 83,400 3,175 5.09%
------- --------
Net interest spread................. $ 2,944 $ 2,812
======= ========
Non-interest bearing demand deposits 10,858 9,710
Accrued expenses and other liabilities 852 1,337
Redeemable common stock............. 239 479
Stockholders' equity................ 10,351 10,039
-------- --------
Total........................... $102,558 $104,965
======== ========
Net interest margin on earning assets 4.30% 4.12%
Net interest spread on earning assets 3.73% 3.69%
<CAPTION>
December 31,
----------------------------------------------------------------
1998 1997
----------------------------------------------------------------
(Fully taxable equivalent) Interest Average Interest Average
(Dollars in thousands) Average Income/ Yields/ Average Income/ Yields/
Balance Expense Rate Balance Expense Rate
------- -------- ------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning assets:
Loans, net of unearned income....... $ 69,356 $ 6,738 9.72% $ 50,120 $ 5,292 10.56%
Investment securities .............. 20,269 1,297 6.40% 19,207 1,317 6.86%
Federal funds sold ................. 3,289 175 3.70% 713 39 5.47%
Other earning assets ............... 16 1 5.32% 3,447 189 5.48%
-------- ------- ---- -------- ------- -----
Total earning assets............ 92,930 8,211 8.83% 73,487 6,837 9.30%
Allowance for loan losses........... (900) (706)
Cash and other assets............... 13,733 8,272
-------- --------
Total........................... $105,763 $ 81,053
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Demand deposits..................... $ 12,287 $ 260 2.12% $ 11,104 $ 247 2.22%
Savings deposits.................... 10,195 374 3.67% 9,430 363 3.85%
Time certificates................... 60,234 3,507 5.82% 43,705 2,703 6.18%
Time deposits of $100,000 or more...
Federal funds and securities
sold under agreement to
repurchase....................
Other borrowings ................... 1,200 89 7.42% -- -- --
-------- ------- -------- -------
Total interest-bearing liabilities 83,916 4,230 5.04% 64,239 3,313 5.16%
------- -------
Net interest spread................. $ 3,981 $ 3,524
======= =======
Non-interest bearing demand deposits 10,490 7,896
Accrued expenses and other liabilities 1,079 2,654
Redeemable common stock.............
Stockholders' equity................ 10,278 6,264
-------- --------
Total........................... $105,763 $ 81,053
======== ========
Net interest margin on earning assets 4.28% 4.80%
Net interest spread on earning assets 3.79% 4.14%
</TABLE>
28
<PAGE> 30
The following table presents a summary of changes in interest income,
interest expense, and the interest rate differential aggregated by the changes
in volumes and rates:
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
versus versus
September 30, 1998 December 31, 1997
Increase (Decrease) Increase (Decrease)
Change due to: (1) Change Due to: (1)
---------------------------------------- -------------------------------------------
(Dollars in Thousands) Volume Rate Mix Total Volume Rate Mix Total
------ ---- --- ----- ------ ---- --- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Earning Assets:
Loans, net of unearned $ 189 $ (382) $ 57 $ (136) $1,870 $ (583) $ 159 $ 1,446
Investment securities............ (138) (84) 48 (174) 68 (93) 5 (20)
Federal funds sold................. 30 (24) 1 7 (8) (5) (0) (14)
Other earning assets .............. -- -- -- -- (26) (0) (12) (38)
------ -------
Total interest income.......... (303) (1,374)
Interest demand.................... 24 (61) 14 (23) 25 (12) 0 13
Savings deposits................... (22) (50) 16 (56) 29 (9) (9) 11
Time less than $100,000............ (293) (95) 88 (300) 962 (217) 59 804
Time greater than $100,000......... 74 (184) 39 (71) -- 0
Other borrowings................... (4) 9 (1) 4 89 -- (0) 89
Securities sold under agreement
to repurchase................... 15 -- (4) 11 -- -- -- 0
------ -------
Total interest expense......... (434) 917
------ -------
Increase in net interest income... $ 132 $ 457
====== =======
</TABLE>
(1) Increases (decreases) are attributable to volume changes and rate changes on
the following basis: Volume Change equals change in volume times prior year
rate. Rate Change equals change in rate times prior year volume. Changes
that are not due solely to volume or rate changes are allocated to volume.
(2) For purposes of this schedule, non-accruing loans are included in the
average balances and tax exempt income is reflected on a tax equivalent
basis. As tax exempt income is exempt only for Federal income tax purposes
and not Tennessee purposes, tax equivalent income is based upon an effective
34% tax rate. Loan fees included in interest income are not material to the
presentation.
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, chief financial officer, 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.
29
<PAGE> 31
Cornerstone operates an external 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, 1998, Cornerstone had
a negative cumulative repricing gap within one year of approximately $3.2
million, or approximately 3.2% 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 September 30, 1999 and December 31, 1998 and 1997. 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.
<TABLE>
<CAPTION>
September 30, 1999
------------------------------------------------------------------------------
Within After 3 months After 12 months
3 months within 12 months Within 5 years After 5 years Total
------------- ---------------- --------------- ------------- -----
<S> <C> <C> <C> <C> <C>
(Dollars in thousands)
EARNING ASSETS:
Loans.............................. $ 6,776 $ 15,836 $ 36,973 $ 10,603 $ 70,188
Investment securities.............. 1,008 2,849 11,330 4,664 19,851
Federal funds sold................. 2,000 -- -- -- 2,000
-------- --------- -------- -------- --------
Interest-bearing deposits..........
Total earning assets........... $ 9,784 $ 18,685 $ 48,303 $ 15,267 $ 92,039
======== ========= ======== ======== ========
INTEREST-BEARING LIABILITIES:
Interest-bearing deposits.......... $ 18,851 $ 32,520 $ 26,974 $ 12 $ 78,357
Other non-deposit borrowing........ 912 912
Long-term debt..................... -- -- -- -- --
-------- --------- -------- -------- --------
Total interest-bearing liabilities. $ 19,763 $ 32,520 $ 26,974 $ 12 $ 79,269
======== ========= ======== ======== ========
Rate sensitivity gap:
Net repricing gap.................. $ (9,979) $ (13,835) $ 21,329 $ 15,255 $ 12,770
Net repricing gap as a percentage
of total earning assets.......... -10.84% -15.03% 23.17% 16.57% 13.87%
Cumulative gap..................... $ (9,979) $ (23,814) $ (2,485) $ 12,770
Cumulative gap as a percentage of
total earning assets............. -10.84% -25.87% -2.70% 13.87%
</TABLE>
30
<PAGE> 32
<TABLE>
<CAPTION>
December 31, 1998
---------------------------------------------------------------------------
Within After 3 months After 12 months
3 months Within 12 months Within 5 years After 5 years Total
-------- ---------------- -------------- ------------- -----
<S> <C> <C> <C> <C> <C>
(Dollars in thousands)
EARNING ASSETS:
Loans ................................ $27,629 $ 10,686 $32,814 $ 2,764 $ 73,893
Investment securities ................ 1,606 4,313 8,681 3,758 18,358
Federal funds sold ................... 8,425 0 0 0 8,425
------- -------- ------- ------- --------
Total earning assets ............. $37,671 $ 14,999 $41,495 $ 6,522 $100,687
======= ======== ======= ======= ========
INTEREST-BEARING LIABILITIES:
Interest-bearing deposits ............ $18,496 $ 36,107 $29,257 $ 0 $ 83,860
Other borrowed funds ................. 1,250 0 0 0 1,250
Total interest-bearing liabilities $19,746 $ 36,107 $29,257 $ 0 $ 85,110
======= ======== ======= ======= ========
Net repricing gap .................... $17,925 $(21,108) $12,238 $ 6,522 $ 15,577
Rate sensitivity gap:
Net repricing gap as a percentage
of total earning assets............. 17.80% -20.96% 12.15% 6.48%
Cumulative gap ....................... $17,925 $ (3,183) $ 9,055 $15,577
Cumulative gap as a percentage of
total earning assets................ 17.80% -3.16% 8.99% 15.67%
<CAPTION>
December 31, 1997
---------------------------------------------------------------------------
Within After 3 months After 12 months
3 months Within 12 months Within 5 years After 5 years Total
-------- ---------------- -------------- ------------- -----
<S> <C> <C> <C> <C> <C>
(Dollars in thousands)
EARNING ASSETS:
Loans ........................................... $ 21,748 $ 9,077 $25,525 $ 5,155 $61,505
Investment securities ........................... 1,424 5,249 10,004 1,579 18,256
Other earnings assets ........................... 55 -- -- -- 55
Federal funds sold .............................. 1,130 -- -- -- 1,130
Total earning assets ........................ $ 24,357 $ 14,326 $35,529 $ 6,734 $80,946
======== ======== ======= ======= =======
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
======== ======== ======= ======= =======
Net repricing gap ............................... $(14,875) $ (6,694) $23,205 $ 6,734 $ 8,370
Rate sensitivity gap:
Net repricing gap as a percentage
of total earning assets........................ -18.38% -8.27% 28.67% 8.32%
Cumulative gap .................................. $(14,875) $(21,569) $ 1,636 $ 8,370
Cumulative gap as a percentage of
total earning assets........................... -18.38% -26.55% 2.02% 10.34%
</TABLE>
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 50% in the within 3 months to 12 months
category and 50% in the 12 months to 5 year category.
31
<PAGE> 33
DEPOSITS
Cornerstone's primary sources of funds are interest-bearing deposits. The
following table sets forth Cornerstone's deposit structure at September 30, 1999
and December 31, 1998 and 1997.
<TABLE>
<CAPTION>
September 30, December 31,
------------- -------------------------
(In Thousands) 1999 1998 1997
------------- -------- -------
<S> <C> <C> <C>
Non interest-bearing deposits:
Individuals, partnerships and corporations............. $ 10,110 $ 13,798 $ 9,184
Certified and official checks.......................... 777 357 89
-------- -------- -------
Total non interest-bearing deposits.................. 10,887 14,152 9,273
Interest-bearing deposits:
Interest-bearing demand accounts....................... 15,283 12,998 13,010
Savings accounts....................................... 10,488 10,283 9,879
Certificates of deposit, less than $100,000............ 36,726 43,089 35,736
Certificates of deposit, greater than $100,000......... 15,861 17,490 13,952
-------- -------- -------
Total interest-bearing deposits...................... 78,357 83,860 72,577
-------- -------- -------
Total deposits....................................... $ 89,244 $ 98,012 $ 81,850
======== ======== ========
</TABLE>
The following table presents a breakdown by category of the weighted average
rate on deposits and the average amount of deposits for the periods as
indicated:
<TABLE>
<CAPTION>
September 30, December 31,
-------------------------------------- ------------------------------------------
1999 1998 1998 1997
------------------- ------------------ -------------------- ------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands)
Non interest-bearing deposits................... $ 10,858 $ 9,710 $ 10,490 $ 7,896
Savings deposits................................ 9,760 3.25% 10,439 3.76% 10,195 3.67% 9,430 3.85%
Time deposits................................... 55,651 5.41% 59,792 5.86% 60,234 5.82% 43,705 6.18%
Interest-bearing demand deposits................ 13,530 1.70% 12,123 2.15% 12,287 2.12% 11,104 2.22%
-------- -------- -------- -------
Total deposits.............................. $ 89,799 $ 92,064 $ 93,206 $72,135
======== ======== ======== =======
</TABLE>
At September 30, 1999 and December 31, 1998 and 1997, time deposits greater
than $100,000 aggregated approximately $16 million, $17 million and $14 million,
respectively. The following tables indicate, as of September 30, 1999, and
December 31, 1998, the dollar amount of $100,000 or more deposits by the time
remaining until maturity (in thousands):
<TABLE>
<CAPTION>
September 30, 1999
---------------------------------------------------------------
3 Months 3 to 12 1 Year through
or less Months 5 years Total
------- ------ ------- -----
<S> <C> <C> <C> <C>
Time certificates $4,321 $7,908 $3,632 $15,861
<CAPTION>
December 31, 1998
---------------------------------------------------------------
3 Months 3 to 12 1 Year through
or less Months 5 years Total
------- ------ ------- -----
<S> <C> <C> <C> <C>
Time certificates $ 7,753 $ 5,480 $ 4,257 $17,490
</TABLE>
32
<PAGE> 34
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 September 30, 1998 and 1999
and December 31, 1998 and 1997.
<TABLE>
<CAPTION>
September 30, December 31,
----------------------- -----------------------
1999 1998 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
(Dollars in Thousands)
Interest-bearing deposits with banks..... $ -- $ 12 $ 11 $ 55
Investment securities:
Available for sale..................... 13,722 10,172 9,280 7,544
Held to maturity....................... 6,129 10,819 9,078 10,780
Federal funds sold....................... 2,000 580 8,425 1,130
Loans:
Real estate............................ 51,717 52,127 52,351 42,716
Commercial and other................... 18,471 22,932 21,541 18,610
-------- -------- -------- --------
Total loans.......................... 70,188 75,059 73,892 61,326
-------- -------- -------- --------
Interest-earning assets ................. $ 92,039 $ 96,642 $100,686 $ 80,836
======== ======== ======== ========
</TABLE>
INVESTMENT PORTFOLIO
At September 30, 1999 and December 31, 1998, obligations of the United
States Government or its agencies represented 9.75% and 16.4% of the investment
portfolio, respectively. The following table presents the composition of the
book value (historical amortized cost basis) of Cornerstone's investment
portfolio at September 30, 1999 and December 31, 1998 and 1997.
<TABLE>
<CAPTION>
September 30, December 31,
(In thousands) 1999 1998 1997
- -------------- ---- ---- ----
<S> <C> <C> <C>
AVAILABLE FOR SALE:
U. S. Treasuries ............................... $ -- $ 400 $ 1,448
Obligations of U.S. Government agencies ........ 809 1,180 1,815
Other securities ............................... 13,055 7,637 4,213
------- ------- -------
Total available for sale ................ $13,864 $ 9,217 $ 7,476
------- ------- -------
HELD TO MATURITY:
Obligations of U.S. Government agencies ........ $ 1,118 $ 52 $ 3,173
Other investment securities .................... 5,011 8,726 7,607
------- ------- -------
Total investment securities held to maturity 6,129 9,078 10,780
------- ------- -------
Total investment portfolio ................ $19,993 $18,295 $18,256
======= ======= =======
</TABLE>
33
<PAGE> 35
The following table presents the maturity distribution of the book
value and estimated market value of Cornerstone's investment portfolio at
September 30, 1999 and December 31, 1998 and 1997. The weighted average yields
on these instruments are presented based on average life.
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------------------------- --------------------------------------
Book Estimated Weighted Book Estimated Weighted
Value Market Value Average Yield Value Market Value Average Yield
-------- ------------ ------------- -------- ------------ -------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Available for sale:
U. S. Treasuries:
Due within 1 year .......................... $ -- $ -- $ 400 $ 403 6.28%
-------- --------
Total ................................... $ -- $ -- $ 400 $ 403 6.28%
======== ======== ======== ========
Obligations of U. S. Government agencies:
Due within 1 year .......................... -- -- 1,180 1,201 6.94%
Due after 10 years ......................... 809 817 6.38% -- --
-------- -------- -------- --------
Total ................................... $ 809 $ 817 6.38% $ 1,180 $ 1,201 6.94%
======== ======== ======== ========
Other investment securities:
Due within 1 year .......................... $ 38 $ 38 3.92% $ 3,598 $ 3,616 5.88%
Due after 1 year but within 5 years ........ 7,842 7,765 6.14% 3,255 3,264 6.20%
Due after 5 years but within 10 years ...... 2,012 1,988 6.47% 784 796 6.67%
Due after 10 years ......................... 3,175 3,126 6.50% -- --
-------- -------- -------- --------
Total ................................... 13,068 12,917 6.27% 7,637 7,676 6.10%
-------- -------- -------- --------
Total available for sale ................ $ 13,876 $ 13,734 6.28% $ 9,217 $ 9,280 6.22%
======== ======== ======== ========
Held to maturity:
Obligations of U.S. Government agencies:
Due within 1 year .......................... -- -- 1,290 1,301 6.09%
Due after 1 year but within 5 years ........ -- -- 126 126 6.89%
Due after 5 years but within 10 years ...... -- -- -- --
Due after 10 years ......................... $ 1,038 $ 1,036 6.01% -- --
-------- -------- -------- --------
Total ................................... $ 1,038 $ 1,036 6.01% $ 1,415 $ 1,427 6.16%
======== ======== ======== ========
Other investment securities:
Due within 1 year .......................... $ 32 $ 32 5.81% $ 1,671 $ 1,687 6.19%
Due after 1 year but within 5 years ........ 1,412 1,401 6.11% 4,809 4,809 6.23%
Due after 5 years but within 10 years ...... 546 543 6.92% 1,183 1,180 6.48%
Due after 10 years ......................... 3,148 3,132 6.50% -- --
-------- -------- -------- --------
Total ................................... 5,138 5,107 6.43% 7,662 7,676 6.26%
-------- -------- -------- --------
Total held to maturity .................. $ 6,177 $ 6,143 6.36% $ 9,078 $ 9,103 6.24%
-------- -------- -------- --------
Total securities ......................... $ 20,053 $ 19,877 6.30% $ 18,295 $ 18,383 6.23%
======== ======== ======== ========
</TABLE>
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 and
to meet the five following objectives; gap management, liquidity, pledging,
return, and local community support. In doing so, Cornerstone will use the
portfolio to provide structure and liquidity that the loan portfolio cannot.
The Management Investment Committee will balance the market and credit risks
against the potential investment return, make 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 Management Investment Committee
is authorized to execute security transactions for the investment portfolio
based on the decisions of the Board Asset/Liability Committee. All the
investment transactions occurring since the previous Board Asset / Liability
Committee meeting are reviewed by the Board Asset / Liability Committee at its
next quarterly 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.
34
<PAGE> 36
LOAN PORTFOLIO
The following table summarizes certain information concerning
Cornerstone's loan portfolio:
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998 December 31, 1997
--------------------- -------------------- --------------------
% of Total % of Total % of Total
Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
Construction and land development ......... $ 5,059 7.21% $ 5,456 7.38% $ 8,581 13.95%
Secured by residential properties ......... 23,712 33.78% 22,638 30.64% 13,152 21.38%
Other real estate loans .................... 22,946 32.69% 24,257 32.83% 20,983 34.12%
Total real estate loans ............... 51,717 73.68% 52,351 70.85% 42,716 69.45%
Commercial and industrial loans ............. 11,743 16.73% 13,164 17.81% 12,194 20.12%
Consumer loans .............................. 6,706 9.55% 8,128 11% 6,241 10.15%
All other loans ............................. 22 0.03% 250 0.34% 175 0.28%
------- ------ ------- ------ ------- ------
Total loans ............................. $70,188 100.00% $73,893 100.00% $61,326 100.00%
======= ====== ======= ====== ======= ======
</TABLE>
The following tables set forth maturities of the loan portfolio and
the sensitivity to interest rate changes of Cornerstone's loan portfolio.
<TABLE>
<CAPTION>
September 30, 1999
-----------------------------------------------------------------
Maturity Range
-----------------------------------------------------------------
One Year One Through Over
(In Thousands) or Less Five Years Five Years Total
-------- ----------- ---------- --------
<S> <C> <C> <C> <C>
Real estate construction loans .............. $ 703 $ 4,118 $ 32 $ 4,853
Real estate mortgage loans .................. 3,352 13,446 30,559 47,357
Commercial and industrial loans ............. 2,267 6,703 3,086 12,056
All other loans ............................. 453 2,877 2,592 5,922
------- ------- ------- -------
Total loans ............................... $ 6,776 $27,144 $36,269 $70,188
======= ======= ======= =======
<CAPTION>
December 31, 1998
-----------------------------------------------------------------
Maturity Range
-----------------------------------------------------------------
One Year One Through Over
(In Thousands) or Less Five Years Five Years Total
-------- ----------- ---------- --------
<S> <C> <C> <C> <C>
Real estate construction loans .............. $ 5,456 $ -- $ -- $ 5,456
Real estate mortgage loans .................. 22,305 23,085 1,505 46,895
Commercial and industrial loans ............. 8,320 4,244 600 13,164
All other loans ............................. 2,974 4,994 410 8,378
------- ------- ------- -------
Total loans ............................... $39,055 $32,323 $ 2,515 $73,893
======= ======= ======= =======
</TABLE>
LOAN POLICY
All lending activities of Cornerstone are under the direct supervision
and control of the Directors Loan Committee, which consists of the chairman,
the chief executive officer, the executive vice president of lending and four
outside 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 90% of the
35
<PAGE> 37
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 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.
36
<PAGE> 38
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 $1.4 million at year end 1998, or 1.89%
of loans outstanding. The following table presents data related to Cornerstone's
reserve for loan losses for the nine months ended September 30, 1999 and the
years ended December 31, 1998 and 1997.
<TABLE>
<CAPTION>
September 30, December 31,
------------- -------------------
(In thousands) 1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Beginning balance ....... $ 1,400 $ 915 $ 201
Provision for loan losses 760 715 273
Bank combination ........ -- -- 457
Net charge-offs ......... (1,175) (230) (17)
------- ------- -----
Ending balance ........ $ 985 $ 1,400 $ 915
======= ======= =====
</TABLE>
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:
<TABLE>
<CAPTION>
September 30, December 31,
------------- -------------------
(Dollars in thousands) 1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Nonaccrual loans ................................................. $ 919 $ 609 $ --
Loans past due 90 days or more to principal or interest payments . 15 114 144
Nonperforming loans as a percentage of net loans before
allowance for loan losses .................................... 1.33% 1.0% 0.02%
Allowance for loan losses as a percentage of nonperforming
loans......................................................... 108.84% 193.64% 635.42%
</TABLE>
At September 30, 1999 and 1998 and December 31, 1998 and 1997, the
allowance for loan losses was allocated as follows:
<TABLE>
<CAPTION>
September 30, December 31,
------------- ------------
(Dollars in thousands) 1999 1998 1998 1997
---------------------- --------------------- ----------------------- ---------------------
% of loans in % of loans in % of loans in % of loans in
each category each category each category each category
Amount to total loans Amount to total loans Amount to total loans Amount to total loans
------ -------------- ------ -------------- ------ -------------- ------ --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial................. $ 169 17.18% $ 182 19.12% $ 249 17.82% $ 182 19.88%
Real estate mortgage....... 733 74.39% 660 69.46% 992 70.85% 637 69.65%
All other ................. 83 8.44% 108 11.42% 159 11.34% 96 10.46%
----- ------ ----- ------ ------- ------ ----- ------
Total................... $ 985 100.00% $ 950 100.00% $ 1,400 100.00% $ 915 100.00%
===== ====== ===== ====== ======= ====== ===== ======
</TABLE>
37
<PAGE> 39
The allocation of the allowance is presented based in part on
evaluations of past history and composition of the loan portfolio. Since these
factors are subject to change, the current allocation of the allowance is not
necessarily indicative of the breakdown of future losses.
CAPITAL RESOURCES/LIQUIDITY
Of primary importance to depositors, creditors and regulators is the
ability to have readily available funds sufficient to repay fully maturing
liabilities. Our 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, we devote resources to projecting on a monthly
basis the amount of funds which will be required and maintain relationships with
a diversified customer base so funds are accessible. Liquidity requirements can
also be met through short-term borrowings or the disposition of short-term
assets which are generally matched to correspond to the maturity of liabilities.
Although we have no formal liquidity policy, in the opinion of
management, its liquidity levels are considered adequate. We are not subject to
any specific liquidity requirements imposed by regulatory orders. Management
believes its liquidity ratios meet or exceed regulatory 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.
38
<PAGE> 40
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table provides certain information regarding the
directors of Cornerstone.
<TABLE>
<CAPTION>
DIRECTOR PRINCIPAL OCCUPATION FOR
NAME AGE POSITIONS SINCE PREVIOUS 5 YEARS
- ----------------------------- --------- --------------------------- -------------- ----------------------------------
<S> <C> <C> <C>
Ramesh V. Amin 53 Director 1996 President, American Plastics, Inc.
Randy Brooks 47 Director 1996 President, R. K. Haskew &
Company, Inc.
B. Kenneth Driver 64 Director 1996 President and Chief Operation
Officer, Fillauer, Inc.
Karl Fillauer 52 Director 1996 Chairman, Fillauer, Inc.
Gregory B. Jones 47 Chief Executive Officer, 1996 Banker
President, Director
Carolyn C. Johnson 56 Executive Vice 1996 Banker
President, Director
James H. Large 56 Director 1996 President, Key James Brick &
Supply Company, Inc.
Lawrence D. Levine 70 Director 1996 President, Financial Management
Corp.
Russell W. Lloyd 59 Director 1996 President, MPL Construction Co.,
Inc.
Earl A. Marler, Jr. 63 Chairman of the Board 1996 Banker
Doyce G. Payne, M.D. 49 Director 1996 Physician
Turner Smith 59 Director 1996 Director, Southeast Energy
Services, Inc.
Billy O. Wiggins 57 Director 1996 President, Checks, Inc.
Marsha Yessick 52 Director 1996 Owner, Yessick's Design Center
</TABLE>
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:
GREGORY B. JONES, Chief Executive Officer and President, was employed
at Pioneer Bancshares, Chattanooga, Tennessee as the Chief Financial Officer
from 1994 to 1998. From 1978 to 1994 Mr. Jones served as the Comptroller of the
Pioneer Bank, the banking subsidiary of Pioneer Bancshares. His duties consisted
of primarily administrative responsibilities for the holding company and the 3
subsidiary banks and direct managerial responsibilities for 2 affiliate
companies he created; Pioneer Securities and Center Finance. Prior to his
employment with Pioneer, Mr. Jones worked at Compass Bank in Huntsville, Alabama
as an accounting officer. He received his B.S. in Business Administration from
the University of Alabama and his M.B.A. from The University of Tennessee at
Chattanooga. He is a graduate of numerous banking schools and serves as an
instructor for the Tennessee Bankers Association.
NATHANIEL F. HUGHES, Executive Vice President and Chief Financial
Officer, was employed at Pioneer Bancshares as the Chief Investment Officer from
1994 to 1998. His duties were primarily administrative and concentrated in asset
liability management, portfolio management, budgeting and cash management. From
1983 to
39
<PAGE> 41
1991 Mr. Hughes worked at SunTrust Bank as an investment officer. From 1980 to
1983 he served as a Platoon Commander in the United States Marine Corps.
He received his B.B.A. from the University of Kentucky and M.B.A. from
Vanderbilt University. He holds a Certified Financial Analyst (CFA) designation.
He currently serves as a Commander of an artillery battalion in the United
States Marine Corps Reserve.
JERRY D. LEE, Executive Vice President and Senior Loan Administrator,
was employed from 1996 to 1999 with Northwest Georgia Bank as Senior Loan
Officer and Manager of Investor Mortgage Lending. In that position, his primary
responsibilities included management of credit underwriting, commercial and
consumer production and oversight of Investor Mortgage Lending. From 1990 to
1996, Mr. Lee was employed by Amsouth Bank, where he managed various commercial
and consumer lending departments. From 1983 to 1990, he was employed by SunTrust
Bank, where he managed credit administration and had commercial loan production
responsibilities. He received his B.S. in Finance from the University of
Tennessee at Chattanooga.
DIRECTORS' COMPENSATION
All directors receive $450 for attending each regular board meeting and
non-employee directors receive $75 for each committee meeting.
EXECUTIVE COMPENSATION
The following table sets forth the aggregate cash compensation paid by
Cornerstone to the chairman of its board. No other executive officer of
Cornerstone received cash compensation in excess of $100,000 (determined as of
the end of 1998) for the years ended December 31, 1998, 1997 and 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
ANNUAL COMPENSATION COMPENSATION
------------------- ------------
SECURITIES
UNDERLYING
NAME AND POSITION YEAR SALARY ($) BONUS ($) OPTIONS/SARS(#)
- ----------------- ---- ---------- --------- ---------------
<S> <C> <C> <C> <C>
EARL A. MARLER, JR.............................. 1998 $ 74,000 $ --
CHAIRMAN OF THE BOARD 1997 67,500 3,375
1996 65,000(1) -- 10,000(2)
</TABLE>
(1) Annualized rate.
(2) Option to purchase 10,000 shares of Cornerstone common stock awarded
pursuant to the Cornerstone Statutory-Nonstatutory Stock Option Plan.
STOCK OPTION GRANTS
As of September 30, 1999, non-qualified options to purchase 140,000
shares of the common stock of Cornerstone were issued and outstanding and had an
exercise price of $10 per share. All of these options are held by the officers
and directors of Cornerstone.
SECURITIES LAW LIMITATIONS
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to our directors, officers or controlling persons, we have
been advised that, in the opinion of the SEC, such indemnification is against
public policy as expressed in the Securities Act and is, therefore,
unenforceable.
40
<PAGE> 42
CERTAIN BENEFIT PLANS AND AGREEMENTS
401(k) Plan
Cornerstone has a 401(k) plan covering employees meeting certain age
requirements. The plan is structured such that employees can contribute to the
plan on a tax-deductible basis and have their contributions invested in various
investment funds offered under the plan. The plan permits, but does not require,
Cornerstone to make an employer matching contribution during any plan year.
Employer contributions, which represent 25% of the first 6% of an employee's
salary contributed to the plan, totaled $10,850 for 1998 and $7,491 for 1997.
Cornerstone Statutory-Nonstatutory Stock Option Plan
Cornerstone established the Statutory-Nonstatutory Stock Option Plan
during 1996 as a long-term incentive for eligible employees and directors. The
total number of shares that may be issued under the plan may not exceed 205,000.
Of such shares, 55,000 may be incentive stock options and the remaining 150,000
shares of stock may be nonqualified stock options. The persons eligible to
receive incentive stock options under the plan are key Cornerstone employees and
officers selected by the Plan Committee. Persons designated by the Committee who
are eligible to receive non-qualified options need not be employees of
Cornerstone and generally will be non-employee directors or advisory directors
of Cornerstone. The options are issued at the market value of the bank's stock
and are exercisable upon issuance. The term of each option is 10 years.
As of December 31, 1999, non-qualified options had been issued for
140,000 shares of common stock, all having an exercise price of $10 per share
and all issued to directors of Cornerstone. Incentive stock options for 21,500
shares of common stock had been issued to officers of Cornerstone as of that
date.
EMPLOYMENT AGREEMENTS
Cornerstone has entered into employment agreements with 3 members of
senior management: Gregory B. Jones, Nathaniel F. Hughes, and Jerry D. Lee. The
agreements are in effect for a period of three years and are due to expire in
April 2002.
Each agreement contains change of control provisions which require a
potential successor to negotiate with the employee as a condition to
acquisition. The final employment agreement between the successor entity and the
employee must be for a period of at least two years with a similar compensation
package. If the employee is terminated, he must receive all compensation due to
him at that date plus two years' base salary. If such a termination payment is
made to the employee, he will agree not to engage in any business or activity
within the Chattanooga Standard Metropolitan Statistical Area which is directly
or indirectly in competition with the potential successor.
CERTAIN 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.
41
<PAGE> 43
PRINCIPAL SHAREHOLDERS
As of December 31, 1999, Cornerstone's records indicated that the
following number of shares were beneficially owned by (i) each person known by
Cornerstone to beneficially own more than 5% of Cornerstone's shares; (ii) each
director of Cornerstone and executive officer; and (iii) all directors and
executive officers of Cornerstone as a group. Unless otherwise indicated,
beneficial ownership is direct and the person indicated has sole voting and
investment power.
<TABLE>
<CAPTION>
AMOUNT AND NATURE
OF BENEFICIAL
OWNERSHIP PERCENT
NAME OF BENEFICIAL OWNER (NUMBER OF SHARES) OF CLASS(1)
------------------------ ------------------ -----------
<S> <C> <C>
Ramesh V. Amin (2) .................................................. 70,001 5.4%
Randy Brooks (2)..................................................... 29,746 2.3
B. Kenneth Driver (2)(3) ............................................ 25,186 1.9
Karl Fillauer (2)(4)................................................. 33,190 2.5
Carolyn C. Johnson (2)(5)............................................ 33,240 0.5
Gregory B. Jones .................................................... 7,000 *
James H. Large (2)(6)................................................ 39,670 3.0
Lawrence D. Levine (2)............................................... 17,500 1.3
Russell W. Lloyd (2)(7).............................................. 33,290 2.6
Earl A. Marler, Jr. (2)(8)........................................... 37,065 2.8
Doyce G. Payne, M.D (2)(9) .......................................... 41,315 3.2
Turner Smith (2)..................................................... 30,000 2.3
Billy O. Wiggins (2)(10)............................................. 48,044 3.7
Marsha Yessick (2)................................................... 26,000 2.0
Directors and executive officers as a group (14 persons)............. 508,947 39.0%
</TABLE>
- -----------
* Less than 1%
(1) Unless otherwise indicated, beneficial ownership consists of sole
voting and investing power based on 1,166,629 shares issued and
outstanding on December 31, 1999. Options to purchase 140,000 shares
are exercisable or become exercisable within 60 days of December 31,
1999. Such shares are deemed to be outstanding for the purpose of
computing the percentage of outstanding shares owned by each person to
whom a portion of such options relate but are not deemed to be
outstanding for the purpose of computing the percentage owned by any
other person.
(2) Includes 10,000 shares issuable within the next 60 days upon the
exercise of options issued pursuant to the Cornerstone Statutory-
Nonstatutory Stock Option Plan.
(3) Includes 15,186 shares held jointly with Mr. Driver's spouse.
(4) Includes 23,190 shares held jointly with Mr. Fillauer's spouse.
(5) Includes 23,240 shares held jointly with Ms. Johnson's spouse.
(6) Includes 4,300 shares held jointly with Mr. Large's spouse, 1,600
shares held by Mr. Large's spouse and 22,170 shares held by Key
James Brick & Supply Trust PSP.
(7) Includes 20,000 shares held jointly with Mr. Lloyd's spouse and 100
shares held as custodian for grandchild.
(8) Includes 27,065 shares held jointly with Mr. Marler's spouse.
(9) Includes 10,690 shares held jointly with Dr. Payne's spouse and 2,625
shares held as custodian for child.
(10) Includes 6,190 shares held jointly with Mr. Wiggins' spouse, 7,500
shares jointly held with Mr. Wiggins' spouse and mother and 3,000
shares held as custodian for child.
42
<PAGE> 44
DESCRIPTION OF CAPITAL STOCK
GENERAL MATTERS
Our authorized capital stock consists of 2,000,000 shares of common
stock $1.00 par value per share, of which 1,166,329 shares are issued and
outstanding as of September 30, 1999, and 2,000,000 shares of preferred stock,
no par value, of which no shares are issued and outstanding. We have reserved
205,000 shares of common stock for issuance pursuant to director and executive
officer stock options.
COMMON STOCK
The holders of Cornerstone common stock are entitled to one vote for
each share held of record on all matters submitted to a vote of shareholders.
Cumulative voting is not allowed. Holders of common stock are entitled to
receive ratably such dividends, if any, as may be declared by the Board out of
funds legally available therefor and, in the event of liquidation, dissolution
or winding up of Cornerstone, will be entitled to share ratably in all assets
remaining after payment of liabilities. Holders of common stock have no
preemptive rights and have no right to convert their common stock into any other
securities. All outstanding shares of common stock are fully paid and
nonassessable. Cornerstone Community Bank, Chattanooga, Tennessee, acts as the
transfer agent and registrar for Cornerstone common stock.
Holders of Cornerstone common stock are entitled to receive ratably
such dividends, if any, as may be declared by the Board from funds legally
available whether in cash or stock; provided, however, that the declaration and
payment of dividends by the Board shall be subject to the rules and regulations
of the Tennessee Department of Financial Institutions and the Federal Deposit
Insurance Corporation, which govern the amount of dividends which may be paid to
shareholders, the manner in which dividends are paid, and the methods, if any,
by which capital stock and surplus may be retired and reduced. For more
information on the declaration of dividends, please see "Dividend Policy."
PREFERRED STOCK
Preferred stock may be issued by vote of the Board without shareholder
approval, subject in all respects to approval by the Tennessee Department of
Financial Institutions under the provisions of the Tennessee Code. The preferred
stock may be issued in one or more classes and series, with such designations,
full or limited voting rights (or without voting rights), redemption,
conversion, or sinking fund provisions, dividend rates or provisions,
liquidation rights, and other preferences and limitations as the Board may
determine in the exercise of its business judgment. The preferred stock may be
issued by the Board for a variety of reasons. Cornerstone has no present plans
to issue any of its preferred stock.
The preferred stock could be issued in public or private transactions
in one or more (isolated or series of) issues. The shares of any issue of
preferred stock could be issued with rights, including voting, dividend, and
liquidation features, superior to those of any issue or class of common stock,
including the shares of common stock subject to this offering. The issuance of
shares of the preferred stock could dilute the voting rights or ownership
percentage of holders of the shares (or any other shares of common stock). The
issuance of shares of the preferred stock might also serve to deter or block any
attempt to obtain control of Cornerstone, or to facilitate any such attempt.
CONTROL-SHARE ACQUISITION PROVISIONS
Cornerstone's Charter includes a control-share acquisition provision.
Under this provision, acquirers of control blocks of stock are required to
obtain disinterested shareholder approval or the affirmative vote of 75% of the
Cornerstone Board in order to vote such shares. The Charter provides that no
person shall make a control-share
43
<PAGE> 45
acquisition by directly or indirectly offering to acquire, or acquiring the
beneficial ownership of more than 10% of any class of an equity security of
Cornerstone. In the event a control-share acquisition is made in violation of
the Charter, all stock beneficially owned by any person in excess of 10% shall
be considered "excess stock" and shall not be counted as stock entitled to vote
and shall not be voted by any person or counted as voting shares in connection
with any matters submitted to the shareholders for a vote.
Any person who proposes to make or has made a control-share acquisition
may at the person's election deliver an acquiring person statement to
Cornerstone at Cornerstone's principal office. The acquiring person statement
must set forth all of the following: (i) the identity of the acquiring person
and each other member of any group of which the person is a part for purposes of
determining control shares; (ii) a statement that the acquiring person statement
is given pursuant to Article 11 of the Charter; (iii) the number of shares of
Cornerstone owned, directly or indirectly, by the acquiring person and each
other member of the group; (iv) the range of voting power under which the
control-share acquisition falls or would, if consummated, fall; (v) if the
control-share acquisition has not taken place: (a) a description in reasonable
detail of the terms of the proposed control-share acquisition; and (b)
representations of the acquiring person, together with a statement, in
reasonable detail, of the facts upon which they are based, that the proposed
control-share acquisition, if consummated, will not be contrary to law and that
the acquiring person has the financial capacity to make the proposed
control-share acquisition.
If the acquiring person so requests at the time of delivery of an
acquiring person statement and gives an undertaking to pay Cornerstone's
expenses of an annual meeting, within 10 days thereafter, the directors of
Cornerstone or others authorized to call such a meeting under Cornerstone's
By-Laws shall call a special meeting of shareholders of Cornerstone for the
purpose of considering the voting rights to be accorded the shares acquired or
to be acquired in the control-share acquisition. Unless the acquiring person
agrees in writing to another date, the special meeting of shareholders shall be
held within 50 days after receipt by Cornerstone of the request. If the
acquiring person so requests in writing at the time of delivery of the acquiring
person statement, the special meeting must not be held sooner than 30 days after
receipt by Cornerstone of the acquiring person statement. If no request is made,
the voting rights to be accorded the shares acquired in the control-share
acquisition shall be presented to the next special or annual meeting of the
shareholders.
If a special meeting is requested, notice of the special meeting of
shareholders shall be given as promptly as reasonably practicable by Cornerstone
to all shareholders of record as of the record date set for the meeting, whether
or not entitled to vote at the meeting. Notice of the special or annual
shareholder meeting at which the voting rights are to be considered must include
or be accompanied by both of the following: (a) a copy of the acquiring person
statement delivered to Cornerstone pursuant to Article 11 of the Charter; (b) a
statement by the Cornerstone Board, authorized by its directors, of its position
or recommendation, or that it is taking no position or making no recommendation,
with respect to the proposed control-share acquisition.
Control shares acquired in a control-share acquisition have voting
rights as were accorded the shares before the control-share acquisition only to
the extent granted by resolution approved by a majority of the shares other than
the interested shares or by the affirmative vote of 75% of the Cornerstone
Board, excluding any director who is proposing to make a control share
acquisition or who is a member of a group making or proposing to make a control
share acquisition.
To be approved by the shareholders, the resolution must be approved by:
(a) each class or series entitled to vote separately on the proposal by a
majority of all the votes entitled to be cast by the class or series with the
holders of the outstanding shares of a class or series being entitled to vote as
a separate class; and (b) each class or series entitled to vote separately on
the proposal by a majority of all the votes entitled to be cast by that group,
excluding all interested shares.
44
<PAGE> 46
INDEMNIFICATION OF DIRECTORS AND OFFICERS
Cornerstone's Charter and By-Laws provide that it may indemnify, to the
maximum extent permitted by law, a director, officer, employee or agent who is a
party to any litigation or proceeding by reason of the fact that he is or was a
director, officer, employee or agent of Cornerstone. Such indemnification may
include reasonable expenses incurred in connection with the action, suit or
proceeding, civil or criminal, except as may be otherwise limited by law and
provided that he has not been adjudged liable for negligence or misconduct. Such
indemnification will be in accordance with the provisions of the Tennessee
Banking Act and the Tennessee Business Corporation Act and applicable rules and
regulations of all governmental authorities (including but not limited to the
Federal Deposit Insurance Corporation, the Tennessee Department of Financial
Institutions, and the Federal Reserve Board) as they may exist from time to
time.
MARKET FOR THE SHARES
Prior to this offering, there has been no public market for our common
stock. It is not contemplated that a market will develop after this offering. We
have no present intention to list the shares of common stock on any national
securities exchange.
LEGAL MATTERS
The legality of the common stock offered hereby will be passed upon for
Cornerstone by Baker, Donelson, Bearman & Caldwell, a professional corporation,
Johnson City, Tennessee.
EXPERTS
The consolidated financial statements of Cornerstone Bancshares, Inc.
and subsidiaries included herein have been so included in reliance on the report
of Hazlett, Lewis & Bieter, PLLC, independent certified public accountants,
given on the authority of said firm as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a Registration Statement on Form S-1 (File
No. 333-_____) regarding the common stock being offered by this prospectus. This
prospectus does not contain all of the information presented in the registration
statement. For further information about us and the common stock, reference is
made to the registration statement and its exhibits. Descriptions in this
prospectus of any contract or other document are not complete. for a more
complete description, you should refer to the registration statement and the
exhibits attached to the registration statement. Copies of the registration
statement, including exhibits, may be examined without charge in the Public
Reference Section of the Securities and Exchange Commission at 450 Fifth Street,
N.W., Room 1024, Washington, D.C. 20549, and the SEC's Regional Offices located
at 500West Madison Street, Suite 1400, Chicago, IL, 60601, and Seven World Trade
Center, 13th Floor, New York, NY 10048, or on the Internet at
http://www.sec.gov. Information about the operation of the Public Reference Room
may be obtained by calling the commission at 1800-SEC-0300. Copies of all or a
portion of the registration statement can be obtained from the Public Reference
Section of the Commission upon payment of prescribed fees.
We are subject to the information and reporting requirements of the
Exchange Act and file periodic reports, proxy statements and other information
with the commission.
We intend to furnish our shareholders with annual reports containing
financial statements audited by our independent accountants and to make
available to our shareholders quarterly reports for the first three quarters of
each fiscal year containing unaudited interim information.
45
<PAGE> 47
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Certified Public Accountants on the Financial Statements................................. F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997 .................................................. F-3
Consolidated Statements of Income for the years ended December 31, 1998 and 1997............................... F-4
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1998 and 1997...... F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1998 and 1997........................... F-6
Notes to Consolidated Financial Statements..................................................................... F-7
Consolidated Statements of Condition as of September 30, 1999 and December 31, 1998 (unaudited)................ F-25
Consolidated Statements of Income for the Three and Nine Months ended September 30, 1999
and 1998 (unaudited) ................................................................................. F-26
Consolidated Statement of Cash Flows for the Nine Months ended September 30, 1999
and 1998 (unaudited).................................................................................. F-27
Notes to Consolidated Financial Statements..................................................................... F-28
</TABLE>
F-1
<PAGE> 48
[LOGO]
HAZLETT, LEWIS
& BIETER, PLLC
CERTIFIED PUBLIC ACCOUNTANTS
AND BUSINESS ADVISORS
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 sheets of Cornerstone
Bancshares, Inc. and subsidiary as of December 31, 1998 and 1997, and the
related consolidated statements of income, changes in stockholders' equity, and
cash flows for the years 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 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 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 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 Cornerstone
Bancshares, Inc. and subsidiary as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
/s/ Hazlett, Lewis & Bieter, PLLC
Chattanooga, Tennessee
January 15, 1999
F-2
<PAGE> 49
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
------------ -----------
<S> <C> <C>
ASSETS
Cash and due from banks..................................... $ 4,268,967 $ 6,173,892
Federal funds sold.......................................... 8,425,000 1,130,000
Securities available for sale............................... 9,280,116 7,544,579
Securities held to maturity................................. 9,077,465 10,779,662
Loans receivable, net of allowance for loan losses.......... 72,492,549 60,411,312
Bank premises and equipment................................. 1,967,329 1,944,219
Accrued interest receivable................................. 638,441 584,446
Excess cost over fair value of net assets acquired.......... 2,834,124 2,862,580
Other assets................................................ 1,522,143 1,093,520
------------ -----------
Total assets...................................... $110,506,134 $92,524,210
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand deposits....................... $ 14,151,526 $ 9,416,616
Interest-bearing demand deposits.......................... 12,998,223 12,865,529
Savings deposits and money market accounts................ 10,283,103 9,879,431
Time deposits of $100,000 or more......................... 17,489,618 13,951,562
Time deposits under $100,000.............................. 43,089,138 35,736,667
------------ -----------
Total deposits.................................... 98,011,608 81,849,805
Accrued interest payable.................................... 270,634 325,551
Other liabilities........................................... 470,861 421,972
Notes payable............................................... 1,250,000 855,000
------------ -----------
Total liabilities................................. 100,003,103 83,452,328
------------ -----------
Redeemable common stock..................................... 478,744 856,797
------------ -----------
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; 1,009,461 and 874,954 shares issued and
outstanding in 1998 and 1997, respectively............. 1,009,461 874,954
Additional paid-in capital................................ 9,017,430 7,587,441
Retained earnings (deficit)............................... (41,695) (290,027)
Accumulated other comprehensive income.................... 39,091 42,717
------------ -----------
Total stockholders' equity........................ 10,024,287 8,215,085
------------ -----------
Total liabilities and stockholders' equity........ $110,506,134 $92,524,210
============ ===========
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-3
<PAGE> 50
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Interest income:
Loans..................................................... $6,739,054 $3,408,638
Securities:
U.S. Treasury.......................................... 218,590 24,247
U.S. government agencies............................... 474,718 232,746
Other.................................................. 603,305 493,831
Income on federal funds sold and deposits in bank......... 176,299 135,476
---------- ----------
Total interest income............................. 8,211,966 4,294,938
---------- ----------
Interest expense:
Interest on time deposits of $100,000 or more............. 988,663 589,085
Interest on other deposits................................ 3,152,473 1,552,016
Interest on federal funds purchased....................... 8,518 318
Other..................................................... 81,736 12,038
---------- ----------
Total interest expense............................ 4,231,390 2,153,457
---------- ----------
Net interest income before provision for loan
losses......................................... 3,980,576 2,141,481
Provision for loan losses................................... 715,343 273,277
---------- ----------
Net interest income after provision for loan
losses......................................... 3,265,233 1,868,204
---------- ----------
Noninterest income:
Service charges........................................... 467,718 197,414
Other noninterest income.................................. 108,304 24,957
Net gains from sale of loans.............................. 110,218 --
---------- ----------
Total noninterest income.......................... 686,240 222,371
---------- ----------
Noninterest expenses:
Salaries and employee benefits............................ 1,669,883 928,270
Net occupancy and equipment expense....................... 224,717 108,614
Other operating expenses.................................. 1,656,585 685,257
---------- ----------
Total noninterest expenses........................ 3,551,185 1,722,141
---------- ----------
Income before income tax expense.................. 400,288 368,434
Income tax expense.......................................... 151,956 144,334
---------- ----------
Net income........................................ $ 248,332 $ 224,100
========== ==========
Earnings per share:
Primary................................................... $ .25 $ .35
========== ==========
Fully diluted............................................. $ .24 $ .33
========== ==========
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-4
<PAGE> 51
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
ACCUMULATED
TOTAL ADDITIONAL RETAINED OTHER
COMPREHENSIVE STOCKHOLDERS' COMMON PAID-IN EARNINGS COMPREHENSIVE
INCOME EQUITY STOCK CAPITAL (DEFICIT) INCOME
------------- ------------- ---------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1996... $ 3,047,276 $1,100,200 $ 34,500 $ 1,903,145 $ 9,431
Bank combination............. 4,232,940 (356,934) 6,961,166 (2,417,272) 45,980
Issuance of common stock..... 1,580,260 131,688 1,448,572 -- --
Redeemable common stock...... (856,797) -- (856,797) -- --
Comprehensive income:
Net income................. $224,100 224,100 -- -- 224,100 --
Other comprehensive income,
net of tax:
Unrealized holding gains
(losses) on securities
available for sale, net
of reclassification
adjustment............. (12,694) (12,694) -- -- -- (12,694)
-------- ----------- ---------- ---------- ----------- --------
Total comprehensive
income............ $211,406
========
BALANCE, December 31, 1997... 8,215,085 874,954 7,587,441 (290,027) 42,717
Redemption of common stock... (350,107) (27,897) (322,210) -- --
Issuance of common stock..... 1,964,187 162,404 1,801,783 -- --
Redeemable common stock...... (49,584) -- (49,584) -- --
Comprehensive income:
Net income................. $248,332 248,332 -- -- 248,332 --
Other comprehensive income,
net of tax:
Unrealized holding gains
(losses) on securities
available for sale, net
of reclassification
adjustment............. (3,626) (3,626) -- -- -- (3,626)
-------- ----------- ---------- ---------- ----------- --------
Total comprehensive
income............ $244,706
========
BALANCE, December 31, 1998... $10,024,287 $1,009,461 $9,017,430 $ (41,695) $ 39,091
=========== ========== ========== =========== ========
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-5
<PAGE> 52
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 248,332 $ 224,100
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization.......................... 421,406 108,251
Provision for loan losses.............................. 715,343 273,277
Gains on sales of loans................................ (110,218) --
Deferred income taxes.................................. (248,610) (38,314)
Proceeds from sales of loans held for sale............. 6,969,087 --
Originations of loans held for sale.................... (6,858,869) --
Changes in other operating assets and liabilities:
Accrued interest receivable.......................... (53,995) (162,195)
Accrued interest payable............................. (54,917) 125,432
Other assets and liabilities......................... (144,068) (371,283)
------------ ------------
Net cash provided by operating activities......... 883,491 159,268
------------ ------------
Cash flows from investing activities:
Proceeds from security transactions:
Securities available for sale.......................... 6,318,245 2,667,213
Securities held to maturity............................ 8,736,045 4,175,386
Purchase of securities available for sale................. (8,139,733) (6,347,646)
Purchase of securities held to maturity................... (7,101,585) --
Net increase in loans..................................... (12,796,580) (20,136,327)
Purchase of bank premises and equipment................... (223,054) (332,638)
Payments related to bank combination...................... (457,637) (4,714,631)
Cash and cash equivalents acquired in bank combination.... -- 5,050,906
------------ ------------
Net cash used in investing activities............. (13,664,299) (19,637,737)
------------ ------------
Cash flows from financing activities:
Net increase in deposits.................................. 16,161,803 19,889,783
Proceeds from borrowings on debt.......................... 395,000 500,000
Redemption of common stock................................ (350,107) --
Issuance of common stock.................................. 1,964,187 1,580,260
------------ ------------
Net cash provided by financing activities......... 18,170,883 21,970,043
------------ ------------
Net increase in cash and cash equivalents................... 5,390,075 2,491,574
Cash and cash equivalents, beginning of year................ 7,303,892 4,812,318
------------ ------------
Cash and cash equivalents, end of year...................... $ 12,693,967 $ 7,303,892
============ ============
Supplemental disclosures of cash flow information:
Cash paid during the period for interest.................. $ 4,215,080 $ 2,028,025
Cash paid during the period for taxes..................... $ 425,171 $ 199,859
============ ============
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-6
<PAGE> 53
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Cornerstone Bancshares, Inc. and
subsidiary (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 FAIR VALUE OF NET ASSETS ACQUIRED
The excess cost over fair value of net assets acquired 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 fair value of net assets acquired 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.
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.
F-7
<PAGE> 54
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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
Bonds, notes, and debentures for which the Bank has the positive intent and
ability to hold to maturity are reported at cost, adjusted for premiums and
discounts that are recognized in interest income using the interest method 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.
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
F-8
<PAGE> 55
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
RECLASSIFICATIONS
Certain amounts in the 1997 financial statements have been reclassified to
conform with the 1998 presentation.
NOTE 2. SECURITIES
Securities have been classified in the balance sheet according to
management's intent as either securities held to maturity or securities
available for sale.
The amortized cost and approximate market value of securities at December
31, 1998 and 1997, is as follows:
<TABLE>
<CAPTION>
1998
---------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Securities available for sale:
U.S. government securities............. $ 400,000 $ 2,644 $ -- $ 402,644
Securities of U.S. government agencies
and corporations.................... 2,550,000 8,032 -- 2,558,032
Mortgage-backed securities............. 6,267,066 61,376 (9,002) 6,319,440
----------- ------- -------- -----------
$ 9,217,066 $72,052 $ (9,002) $ 9,280,116
=========== ======= ======== ===========
Securities held to maturity:
U.S. government securities............. $ 352,082 $ 3,613 $ -- $ 355,695
Mortgage-backed securities............. 8,725,383 47,002 (25,394) 8,746,991
----------- ------- -------- -----------
$ 9,077,465 $50,615 $(25,394) $ 9,102,686
=========== ======= ======== ===========
</TABLE>
<TABLE>
<CAPTION>
1997
---------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
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
=========== ======= ======== ===========
</TABLE>
F-9
<PAGE> 56
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and estimated market value of securities at December 31,
1998, 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.
<TABLE>
<CAPTION>
SECURITIES AVAILABLE FOR SALE SECURITIES HELD TO MATURITY
----------------------------- ---------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
------------- ------------- ------------ ------------
<S> <C> <C> <C> <C>
Due in one year or less............ $ 474,732 $ 479,123 $ 76,307 $ 76,201
Due from one year to five years.... 2,883,700 2,896,431 2,346,492 2,377,466
Due from five years to ten years... 733,346 741,469 682,834 688,886
Due after ten years................ 5,125,288 5,163,093 5,971,832 5,960,133
---------- ---------- ---------- ----------
$9,217,066 $9,280,116 $9,077,465 $9,102,686
========== ========== ========== ==========
</TABLE>
Proceeds from the sale of securities were $2,572,054 in 1997 which were
sold at book value. There were no sales in 1998.
Securities with a book value of approximately $5,116,000 and $5,697,000 at
December 31, 1998 and 1997, respectively, 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 years
ended December 31, 1998 and 1997, is as follows:
<TABLE>
<CAPTION>
1998 1997
---------- --------
<S> <C> <C>
Balance, beginning of year................................. $ 915,005 $201,422
Provision charged to operating expense..................... 715,343 273,277
Bank combination........................................... -- 456,960
Loans charged off, net..................................... (230,348) (16,654)
---------- --------
Balance, end of year....................................... $1,400,000 $915,005
========== ========
</TABLE>
At December 31, 1998 and 1997, the Bank's loans consist of the
following (in thousands):
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Real estate loans........................................... $52,351 $42,716
Commercial and industrial loans............................. 13,164 12,194
Loans to individuals for household, family, and other
consumer expenditures..................................... 8,127 6,241
Other....................................................... 250 175
------- -------
Total loans....................................... 73,892 61,326
Less -- Allowance for loan losses......................... (1,400) (915)
------- -------
Net loans......................................... $72,492 $60,411
======= =======
</TABLE>
The Bank's only significant concentration of credit at December 31, 1998,
occurred in real estate loans which totaled approximately $52,351,000. While
real estate loans accounted for 70 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
<PAGE> 57
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (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 $2,987,000 at December 31, 1998.
At December 31, 1998 and 1997, loans that were specifically classified as
impaired were insignificant in relation to the Bank's loan portfolio.
NOTE 4. BANK PREMISES AND EQUIPMENT
A summary of bank premises and equipment at December 31, 1998 and 1997, is
as follows:
<TABLE>
<CAPTION>
1998 1997
----------- ----------
<S> <C> <C>
Land.................................................... $ 463,278 $ 463,278
Buildings and improvements.............................. 1,091,255 1,017,986
Furniture, fixtures and equipment....................... 1,419,645 1,282,946
----------- ----------
2,974,178 2,764,210
Accumulated depreciation................................ (1,006,849) (819,991)
----------- ----------
$ 1,967,329 $1,944,219
=========== ==========
</TABLE>
The charge to operating expense for depreciation was $199,944 in 1998 and
$108,251 in 1997.
Certain bank facilities and equipment are leased under various operating
leases. Rental expense was $89,657 in 1998 and $28,324 in 1997.
Future minimum rental commitments under noncancelable leases are as
follows:
<TABLE>
<S> <C>
1999........................................................ $ 70,241
2000........................................................ 61,681
2001........................................................ 61,425
2002........................................................ 44,721
--------
Total............................................. $238,068
========
</TABLE>
NOTE 5. TIME DEPOSITS
At December 31, 1998, the scheduled maturities of time deposits are as
follows:
<TABLE>
<S> <C>
1999..................................................... $42,962,759
2000..................................................... 9,586,956
2001..................................................... 6,565,136
2002..................................................... 647,539
Thereafter............................................... 816,366
-----------
Total.......................................... $60,578,756
===========
</TABLE>
F-11
<PAGE> 58
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6. INCOME TAXES
Income tax expense in the statement of income for the years ended December
31, 1998 and 1997, consists of the following:
<TABLE>
<CAPTION>
1998 1997
--------- --------
<S> <C> <C>
Current tax expense........................................ $ 400,566 $182,648
Deferred income taxes related to:
Provision for loan losses................................ (199,449) (24,700)
Net operating loss carryforward.......................... (11,121) (8,000)
Other.................................................... (38,040) (5,614)
--------- --------
Income tax expense.................................... $ 151,956 $144,334
========= ========
</TABLE>
The income tax benefit is different from the expected tax benefit computed
by multiplying income before income tax benefit by the statutory federal income
tax rates. The reasons for this difference are as follows:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Expected tax at statutory rates............................. $136,097 $125,268
Increase (decrease) resulting from tax effect of:
State income taxes, net of federal tax benefit............ 16,013 14,737
Other nondeductible expenses.............................. (154) 4,329
-------- --------
Income tax expense..................................... $151,956 $144,334
======== ========
</TABLE>
The Bank had a net operating loss carryforward for tax purposes of
approximately $29,000 at December 31, 1997, which was carried forward and used
to offset taxable income in 1998.
As of December 31, 1998, deferred tax assets recognized for deductible
temporary differences totaled approximately $620,000 and deferred tax
liabilities for taxable temporary differences totaled approximately $131,000.
NOTE 7. NOTES PAYABLE
Notes payable represent borrowings under a $1,000,000 revolving line of
credit and a promissory note dated September 30, 1998, with First Tennessee
Bank. Borrowings are 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 7.75% at December 31, 1998. The line of credit agreement expires
and the promissory note matures on January 30, 1999. The Company intends to
renew the revolving line of credit at maturity and increase its borrowing amount
by $250,000 in order to payoff the promissory note.
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 percent 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 $10,850 in 1998 and
$7,491 in 1997.
F-12
<PAGE> 59
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, 1998, commitments under standby letters of credit and
undisbursed loan commitments aggregated $5,167,000. 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.
NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS
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 the Company's entire holdings of a particular financial instrument.
Because no market exists for a significant portion of the Company'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.
F-13
<PAGE> 60
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
LOANS
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, and savings accounts, 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.
NOTES PAYABLE
The carrying amount of notes payable approximates their fair value.
The carrying amount and estimated fair value of the Company's financial
instruments at December 31, 1998, are as follows (in thousands):
<TABLE>
<CAPTION>
CARRYING ESTIMATED
AMOUNT FAIR VALUE
-------- ----------
<S> <C> <C>
Assets:
Cash and due from banks................................... $ 4,269 $ 4,269
Federal funds sold........................................ 8,425 8,425
Securities................................................ 18,357 18,383
Net loans................................................. 72,492 72,480
Liabilities:
Noninterest-bearing demand deposits....................... 14,152 14,152
Interest-bearing demand deposits.......................... 12,998 12,998
Savings deposits and money market accounts................ 10,283 10,283
Time deposits............................................. 60,579 60,606
Notes payable............................................. 1,250 1,250
</TABLE>
NOTE 11. 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 materially affect the
Bank's financial position.
The Company is engaged in a comprehensive project to ready the Bank's
computer software and hardware systems for year 2000 compliance. Based on
current estimates, spending to upgrade or replace the Company's software of
hardware systems related to year 2000 compliance is not expected to be a
material amount through 1999. Although it is not possible to quantify the
effects year 2000 compliance issues will have on customers or operations, the
Company does not anticipate related material adverse effects on its financial
position, liquidity or results of operations.
F-14
<PAGE> 61
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12. 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 14,
the Bank cannot pay dividends until March 1999 and then must receive specific
regulatory approval for any dividend payments.
NOTE 13. 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 150,000 shares of the
Bank's common stock. The option 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.
No options have been exercised since the original grant date. At December 31,
1998, the remaining contractual life of outstanding options was 7.5 years.
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, 1998
and 1997, warrants for the purchase of 323,935 and 458,442 shares, respectively,
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 134,507 and 131,688 warrants were exercised in 1998 and 1997,
respectively.
NOTE 14. 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, 1998, that the Bank
meets all capital adequacy requirements to which it is subject.
As of December 31, 1998, the most recent notification from the Federal
Deposit Insurance Corporation 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 for bank capital.
F-15
<PAGE> 62
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Bank's actual capital amounts and ratios are also presented in the
table. Dollar amounts are presented in thousands.
<TABLE>
<CAPTION>
FOR CAPITAL
ACTUAL ADEQUACY PURPOSES
-------------- -------------------
AMOUNT RATIO AMOUNT RATIO
------ ----- -------- --------
<S> <C> <C> <C> <C>
As of December 31, 1998:
Total capital (to risk-weighted assets)....... $9,808 12.8% $6,136 8.0%
Tier I capital (to risk-weighted assets)...... 8,844 11.5 3,068 4.0
Tier I capital (to average assets)............ 8,844 8.4 8,407 8.0
As of 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
</TABLE>
As a condition of the bank combination described in Note 16, the Bank must
meet 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 December 31, 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, 1998.
The Bank is operating under a Memorandum of Understanding (Memorandum)
dated November 24, 1998, between the Board of Directors, the Tennessee
Department of Financial Institutions, and the Federal Deposit Insurance
Corporation. Among other things, the Memorandum provides the following:
- The Board of Directors shall develop a written management plan that
addresses the Bank's plans for size, structure, growth, earnings,
services, information systems, personnel, accounting, financial reporting
and operating matters.
- The Bank shall maintain a Tier I capital ratio of equal to or greater
than 8%.
- The Bank shall not pay dividends without the prior approval of the FDIC.
- The Bank shall report its progress on the actions required by the
Memorandum to the FDIC on specific dates.
At December 31, 1998, the Bank had reported to the FDIC that it was in
compliance with all provisions of the Memorandum.
F-16
<PAGE> 63
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 15. OTHER COMPREHENSIVE INCOME
Other comprehensive income consists of unrealized holding gains and losses
on securities available for sale. A summary of other comprehensive income and
the related tax effects for the years ended December 31, 1998 and 1997, is as
follows:
<TABLE>
<CAPTION>
TAX
BEFORE-TAX (EXPENSE) NET-OF-TAX
AMOUNT BENEFIT AMOUNT
---------- --------- ----------
<S> <C> <C> <C>
Year ended December 31, 1998:
Unrealized holding gains and losses arising during
the period..................................... $ (5,848) $2,222 $ (3,626)
Less reclassification adjustment for gains
realized in net income......................... -- -- --
-------- ------ --------
$ (5,848) $2,222 $ (3,626)
======== ====== ========
Year ended December 31, 1997:
Unrealized holding gains and losses arising during
the period..................................... $(20,474) $7,780 $(12,694)
Less reclassification adjustment for gains
realized in net income......................... -- -- --
-------- ------ --------
$(20,474) $7,780 $(12,694)
======== ====== ========
</TABLE>
NOTE 16. 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 Company changed its name from East Ridge Bancshares, Inc. to
Cornerstone Bancshares, Inc. concurrent with the combination.
The purchase price totaled $6,125,000 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 $2,800,000, 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-17
<PAGE> 64
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (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):
<TABLE>
<S> <C>
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
======
</TABLE>
NOTE 17. EARNINGS PER SHARE
Primary earnings per share amounts are computed based on the weighted
average number of shares actually outstanding. Fully diluted earnings per share
are computed based on the weighted average number of shares actually outstanding
plus the shares that would be outstanding assuming exercise of dilutive stock
options and stock warrants, all of which are considered to be common stock
equivalents.
<TABLE>
<CAPTION>
1998 1997
--------- -------
<S> <C> <C>
Primary:
Weighted average number of shares actually outstanding.... 987,043 649,468
========= =======
Fully diluted:
Computed above for primary earnings per share............. 987,043 649,468
Stock options............................................. 30,000 28,000
Stock warrants............................................ -- --
--------- -------
1,017,043 677,468
========= =======
</TABLE>
NOTE 18. REDEEMABLE COMMON STOCK
At December 31, 1998 and 1997, the Company was obligated to redeem certain
shares of common stock issued in connection with the bank combination described
in Note 16. Such obligation includes the right of a certain shareholder to sell
certain shares of common stock to the Company over a three-year period at
$12.55, $14.00, and $16.00 per share in years 1998, 1999, and 2000,
respectively. The Company has the option to redeem such shares during the same
period at the same prices. At December 31, 1997, the Company also had a
remaining balance due former East Ridge Bancshares, Inc.'s shareholders totaling
$77,529.
F-18
<PAGE> 65
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 19. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
Condensed financial statements of Cornerstone Bancshares, Inc. are
summarized as follows:
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Cash........................................................ $ 2,934 $ 939,493
Securities held to maturity................................. -- 39,338
Loans receivable, net of allowance for loan losses.......... -- 125,523
Excess cost over fair value of net assets acquired.......... 2,834,124 2,862,580
Other assets................................................ 51,376 --
Investment in subsidiary.................................... 8,883,624 6,764,184
----------- -----------
Total assets...................................... $11,772,058 $10,731,118
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accrued interest payable.................................. $ 19,027 $ --
Other liabilities......................................... -- 804,236
Notes payable............................................. 1,250,000 855,000
----------- -----------
Total liabilities................................. 1,269,027 1,659,236
----------- -----------
Redeemable common stock..................................... 478,744 856,797
----------- -----------
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; 1,009,461 and 874,954 shares issued and
outstanding in 1998 and 1997, respectively............. 1,009,461 874,954
Additional paid-in capital................................ 9,017,430 7,587,441
Retained earnings (deficit)............................... (41,695) (290,027)
Accumulated other comprehensive income.................... 39,091 42,717
----------- -----------
Total stockholders' equity........................ 10,024,287 8,215,085
----------- -----------
Total liabilities and stockholders' equity........ $11,772,058 $10,731,118
=========== ===========
</TABLE>
F-19
<PAGE> 66
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED STATEMENTS OF INCOME AND RETAINED EARNINGS
<TABLE>
<CAPTION>
1998 1997
--------- -----------
<S> <C> <C>
Income:
Net loss from sale of assets........................... $(112,155) $ (103,394)
Equity in subsidiary's earnings........................ 547,672 358,410
--------- -----------
Total income................................... 435,517 255,016
--------- -----------
Expenses:
Interest expense....................................... 122,567 12,038
Other operating expenses............................... 111,194 18,878
--------- -----------
Total expenses................................. 233,761 30,916
--------- -----------
Income before income tax benefit............... 201,756 224,100
Income tax expense (benefit)............................. (46,576) --
--------- -----------
Net income............................................... 248,332 224,100
Retained earnings (deficit), beginning of year........... (290,027) 1,903,145
Bank combination....................................... -- (2,417,272)
--------- -----------
Retained earnings (deficit), end of year................. $ (41,695) $ (290,027)
========= ===========
</TABLE>
F-20
<PAGE> 67
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income........................................... $ 248,332 $ 224,100
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Amortization...................................... 111,170 --
Equity in earnings of subsidiary.................. (547,672) (358,410)
Changes in other operating assets and liabilities:
Increase in accrued interest payable............ 19,027 --
Increase (decrease) in other assets and
liabilities.................................. (743,465) 634,666
----------- -----------
Net cash provided by (used in) operating
activities................................ (912,608) 500,356
----------- -----------
Cash flows from investing activities:
Additional capitalization of subsidiary.............. (1,575,394) (2,080,260)
Payments related to bank combination................. (457,637) (4,714,631)
Cash and cash equivalents acquired in bank
combination....................................... -- 5,050,906
----------- -----------
Net cash used in investing activities........ (2,033,031) (1,743,985)
----------- -----------
Cash flows from financing activities:
Proceeds from borrowings on line of credit........... 145,000 500,000
Proceeds from notes payable.......................... 250,000 --
Redemption of common stock........................... (350,107) --
Issuance of common stock............................. 1,964,187 1,580,260
----------- -----------
Net cash provided by financing activities.... 2,009,080 2,080,260
----------- -----------
Net increase in cash and cash equivalents.............. (936,559) 836,631
Cash and cash equivalents, beginning of year........... 939,493 102,862
----------- -----------
Cash and cash equivalents, end of year................. $ 2,934 $ 939,493
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the period for interest............. $ 103,540 $ 15,353
Cash paid during the period for taxes................ $ 425,171 $ 199,859
=========== ===========
</TABLE>
F-21
<PAGE> 68
[LOGO]
HAZLETT, LEWIS
& BIETER, PLLC
CERTIFIED PUBLIC ACCOUNTANTS
AND BUSINESS ADVISORS
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 audits of the basic financial statements of Cornerstone
Bancshares, Inc. and subsidiary for 1998 and 1997 appears on page F-1. Those
audits were made for the purpose of forming an opinion on the consolidated
financial statements taken as a whole. The consolidating information shown on
pages F-23 and F-24 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 audits 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.
/s/ Hazlett, Lewis & Bieter, PLLC
Chattanooga, Tennessee
January 15, 1999
F-22
<PAGE> 69
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATING BALANCE SHEET
DECEMBER 31, 1998
<TABLE>
<CAPTION>
CORNERSTONE
CORNERSTONE BANCSHARES,
BANK INC. ELIMINATIONS CONSOLIDATED
------------ ----------- ------------ ------------
<S> <C> <C> <C> <C>
ASSETS
Cash and due from banks............... $ 4,268,967 $ 2,934 $ 2,934 $ 4,268,967
Federal funds sold.................... 8,425,000 -- -- 8,425,000
Securities available for sale......... 9,280,116 -- -- 9,280,116
Securities held to maturity........... 9,077,465 -- -- 9,077,465
Loans receivable, net of allowance for
loan losses......................... 72,492,549 -- -- 72,492,549
Bank premises and equipment........... 1,967,329 -- -- 1,967,329
Accrued interest receivable........... 638,441 -- -- 638,441
Excess cost over fair value of net
assets acquired..................... -- 2,834,124 -- 2,834,124
Other assets.......................... 1,470,767 51,376 -- 1,522,143
Investment in subsidiary.............. -- 8,883,624 8,883,624 --
------------ ----------- ---------- ------------
Total assets................ $107,620,634 $11,772,058 $8,886,558 $110,506,134
============ =========== ========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand
deposits......................... $ 14,154,460 $ -- $ 2,934 $ 14,151,526
Interest-bearing demand deposits.... 12,998,223 -- -- 12,998,223
Savings deposits and money market
accounts......................... 10,283,103 -- -- 10,283,103
Time deposits of $100,000 or more... 17,489,618 -- -- 17,489,618
Time deposits under $100,000........ 43,089,138 -- -- 43,089,138
------------ ----------- ---------- ------------
Total deposits.............. 98,014,542 -- 2,934 98,011,608
Accrued interest payable.............. 251,607 19,027 -- 270,634
Other liabilities..................... 470,861 -- -- 470,861
Notes payable......................... -- 1,250,000 -- 1,250,000
------------ ----------- ---------- ------------
Total liabilities........... 98,737,010 1,269,027 2,934 100,003,103
------------ ----------- ---------- ------------
Redeemable common stock............... -- 478,744 -- 478,744
------------ ----------- ---------- ------------
Stockholders' equity:
Preferred stock..................... -- -- -- --
Common stock........................ 590,130 1,009,461 590,130 1,009,461
Additional paid-in capital.......... -- 9,017,430 -- 9,017,430
Surplus............................. 7,862,448 -- 7,862,448 --
Retained earnings (deficit)......... 391,955 (41,695) 391,955 (41,695)
Accumulated other comprehensive
income........................... 39,091 39,091 39,091 39,091
------------ ----------- ---------- ------------
Total stockholders'
equity................... 8,883,624 10,024,287 8,883,624 10,024,287
------------ ----------- ---------- ------------
Total liabilities and
stockholders' equity..... $107,620,634 $11,772,058 $8,886,558 $110,506,134
============ =========== ========== ============
</TABLE>
F-23
<PAGE> 70
CORNERSTONE BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATING STATEMENT OF INCOME
YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
CORNERSTONE CORNERSTONE
COMMUNITY BANCSHARES,
BANK INC. ELIMINATIONS CONSOLIDATED
----------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
Interest income:
Loans...................................... $6,779,885 $ -- $ 40,831 $6,739,054
Securities:
U.S. Treasury........................... 218,590 -- -- 218,590
U.S. government agencies................ 474,718 -- -- 474,718
Other................................... 603,305 -- -- 603,305
Income on federal funds sold and deposits
in bank................................. 176,299 -- -- 176,299
---------- --------- -------- ----------
Total interest income.............. 8,252,797 -- 40,831 8,211,966
---------- --------- -------- ----------
Interest expense:
Interest on time deposits of $100,000 or
more.................................... 988,663 -- -- 988,663
Interest on other deposits................. 3,152,473 -- -- 3,152,473
Interest on federal funds purchased........ 8,518 -- -- 8,518
Other...................................... -- 122,567 (40,831) 81,736
---------- --------- -------- ----------
Total interest expense............. 4,149,654 122,567 (40,831) 4,231,390
---------- --------- -------- ----------
Net interest income (expense)
before provision for loan
losses.......................... 4,103,143 (122,567) -- 3,980,576
Provision for loan losses.................... 715,343 -- -- 715,343
---------- --------- -------- ----------
Net interest income (expense) after
provision for loan losses....... 3,387,800 (122,567) -- 3,265,233
---------- --------- -------- ----------
Noninterest income:
Service charges............................ 467,718 -- -- 467,718
Other noninterest income................... 108,304 -- -- 108,304
Net gains (losses) from sale of loans...... 222,373 (112,155) -- 110,218
Equity in subsidiary's earnings............ -- 547,672 547,672 --
---------- --------- -------- ----------
Total noninterest income........... 798,395 435,517 547,672 686,240
---------- --------- -------- ----------
Noninterest expenses:
Salaries and employee benefits............. 1,669,883 -- -- 1,669,883
Net occupancy and equipment expense........ 224,717 -- -- 224,717
Other operating expenses................... 1,545,391 111,194 -- 1,656,585
---------- --------- -------- ----------
Total noninterest expenses......... 3,439,991 111,194 -- 3,551,185
---------- --------- -------- ----------
Income before income tax benefit... 746,204 201,756 547,672 400,288
Income tax expense (benefit)................. 198,532 (46,576) -- 151,956
---------- --------- -------- ----------
Net income......................... $ 547,672 $ 248,332 $547,672 $ 248,332
========== ========= ======== ==========
</TABLE>
F-24
<PAGE> 71
CORNERSTONE BANCSHARES, INC.
Consolidated Statements of Condition
As of September 30, 1999 and December 31, 1998
<TABLE>
<CAPTION>
Unaudited
ASSETS September 30, December 31,
1999 1998
------------- -------------
<S> <C> <C>
Cash and due from banks ........................................................ $ 4,171,067 $ 4,268,967
Federal funds sold ............................................................. 2,000,000 8,425,000
Investment securities available for sale ....................................... 13,722,139 9,280,116
Investment securities held to maturity ......................................... 6,128,973 9,077,465
Loans, less allowance for loan loss ............................................ 69,287,556 72,492,549
Premises and equipment, net .................................................... 2,057,900 1,967,329
Accrued interest receivable .................................................... 653,862 638,441
Excess cost over fair value of assets acquired ................................. 2,750,747 2,834,124
Other assets ................................................................... 1,893,773 1,522,143
------------- -------------
Total assets ................................................................ $ 102,666,018 $ 110,506,134
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Noninterest bearing ......................................................... $ 10,886,803 $ 14,151,526
NOW accounts ................................................................ 15,282,557 12,998,223
Savings deposits and money market accounts .................................. 10,488,031 10,283,103
Time deposits of $100,000 or more ........................................... 15,860,872 17,489,618
Time deposits of less than $100,000 ......................................... 36,726,204 43,089,138
------------- -------------
Total deposits ....................................................... 89,244,467 98,011,608
Other borrowings ............................................................... 1,044,188 --
Accrued interest payable ....................................................... 175,469 270,634
Other liabilities .............................................................. 331,655 470,861
Note payable ................................................................... -- 1,250,000
------------- -------------
Total liabilities ........................................................... 90,795,779 100,003,103
Redeemable common stock ........................................................ 237,504 478,744
Stockholders' equity:
Common stock .................................................................. 1,166,329 1,009,461
Additional paid-in capital .................................................... 11,124,634 9,017,430
Undivided profits (deficit) ................................................... (559,890) (41,695)
Net unrealized gain on securities available for sale .......................... (98,338) 39,091
------------- -------------
Total stockholders' equity .................................................. 11,870,239 10,503,031
------------- -------------
Total liabilities and stockholders' equity ................................ $ 102,666,018 $ 110,506,134
============= =============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-25
<PAGE> 72
CORNERSTONE BANCSHARES, INC.
Consolidated Statements of Income
For The Three and Nine Months Ended September 30, 1999 and 1998
<TABLE>
<CAPTION>
Unaudited Unaudited
Three months ended Nine months ended
September 30, September 30,
--------------------------- ---------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans ............................... $ 1,626,935 $ 1,750,144 $ 4,689,687 $ 4,825,427
Interest on investment securities: ....................... 305,513 341,449 833,699 1,007,399
Interest on federal funds sold ........................... 36,293 17,485 161,394 154,565
----------- ----------- ----------- -----------
Total interest income .......................... 1,968,741 2,109,078 5,684,780 5,987,391
Interest expense:
Interest bearing demand accounts ......................... 55,565 61,759 172,369 195,353
Money market accounts .................................... 56,988 85,416 156,095 216,519
Savings accounts ......................................... 27,466 25,827 81,352 77,350
Time deposits of less than $100,000 ...................... 515,312 628,126 1,592,998 1,892,671
Time deposits of $100,000 or more ........................ 202,828 272,926 659,737 730,292
Federal funds purchased .................................. 300 6,336 1,032 6,906
Securities sold under agreements to repurchase ........... 6,551 -- 10,269 --
Other borrowings ......................................... 14,648 20,742 67,122 56,207
----------- ----------- ----------- -----------
Total interest expense ............................... 879,658 1,101,132 2,740,974 3,175,298
----------- ----------- ----------- -----------
Net interest income ........................................... 1,089,084 1,007,946 2,943,807 2,812,093
Provision for loan losses ..................................... 105,000 183,478 760,000 306,670
----------- ----------- ----------- -----------
Net interest income after provision for loan losses ........ 984,084 824,468 2,183,807 2,505,423
Noninterest income:
Service charges on deposit accounts ...................... 120,063 165,955 373,727 626,242
Other income ............................................. 31,518 (4,721) 64,629 138,217
----------- ----------- ----------- -----------
Total noninterest income ............................ 151,581 161,234 438,356 764,459
----------- ----------- ----------- -----------
Noninterest expense:
Salaries and employee benefits ........................... 568,057 430,399 1,605,235 1,254,911
Occupancy and equipment expense .......................... 135,221 100,006 397,742 325,442
Other operating expense .................................. 387,143 375,079 1,287,946 1,011,288
----------- ----------- ----------- -----------
Total noninterest expense ............................ 1,090,420 905,484 3,290,922 2,591,641
----------- ----------- ----------- -----------
Income before provision for income taxes ...................... 45,245 80,218 (668,760) 678,241
Provision for income taxes .................................... (58,957) (47,683) (150,564) 114,075
----------- ----------- ----------- -----------
Net income .................................................... $ 104,202 $ 127,901 $ (518,196) $ 564,166
=========== =========== =========== ===========
Basic net income per common share ............................. $ 0.09 $ 0.13 $ (0.44) $ 0.56
Diluted net income per common share ........................... $ 0.08 $ 0.11 $ (0.44) $ 0.54
Dividends declared per common share ........................... -- -- -- --
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-26
<PAGE> 73
CORNERSTONE BANCSHARES, INC.
Consolidated Statement of Cash Flows
For The Nine Months Ended September 30, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ........................................................... $ (518,196) $ 564,166
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Provision for possible loan losses ....................................... 760,000 306,670
Net charge-offs .......................................................... (1,174,766) (271,604)
Provision for depreciation and amortization .............................. 265,846 242,101
Accrued interest receivable .............................................. (15,421) (90,251)
Accrued interest payable ................................................. (95,165) 54,778
Changes in assets and other liabilities .................................. (443,016) (691,860)
------------- -------------
Net cash used in operating activities ....................................... (1,220,717) 114,000
------------- -------------
Cash flows from investing activities:
Purchase of investment securities: available for sale ....................... (9,295,372) (6,365,349)
Purchase of investment securities: held to maturity ......................... -- (8,856,080)
Proceeds from security transactions: available for sale .................... 5,039,365 5,602,129
Proceeds from security transactions: held to maturity ....................... 2,557,272 6,920,641
Net increase in loans ....................................................... 3,619,759 (13,762,936)
Purchase of bank premises and equipment ..................................... (273,085) (181,752)
------------- -------------
Net cash used in investing activities ....................................... 1,647,939 (16,643,347)
------------- -------------
Cash flows from financing activities:
Net increase in deposits .................................................... (8,767,141) 15,108,726
Net increase in repurchase agreements ....................................... 1,044,188 --
Net increase in notes payable ............................................... (1,250,000) --
Issuance of common stock .................................................... 2,022,832 1,548,382
------------- -------------
Net cash provided by financing activities ................................... (6,950,121) 16,657,108
------------- -------------
Net increase in cash and cash equivalents ...................................... (6,522,899) 127,761
Cash and cash equivalents beginning of period .................................. 12,693,967 7,303,892
------------- -------------
Cash and cash equivalents end of period ........................................ $ 6,171,067 $ 7,431,654
============= =============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-27
<PAGE> 74
Cornerstone Bancshares, Inc.
Notes to Consolidated Financial Statements
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 the Company 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 Cornerstone Bancshares Inc. and its sole subsidiary Cornerstone
Community Bank.
Substantially all intercompany transactions, profits and balances have
been eliminated.
Accounting Policies
During interim periods, Cornerstone Bancshares follows the accounting
policies set forth in its 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 number of common shares
outstanding (denominator). Diluted EPS is computed by dividing income available
to common shareholders (numerator) by the number of shares outstanding
(denominator). The adjusted 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 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.
F-28
<PAGE> 75
CORNERSTONE BANCSHARES, INC.
(a Tennessee corporation)
SUBSCRIPTION AGREEMENT
I, ______________________________, do hereby subscribe for
__________________________________ (_____________) shares of the common stock
of Cornerstone Bancshares, Inc. at a price of $13.00 per share. I tender
herewith the purchase price of $_______________ in cash or cash equivalent.
IN WITNESS WHEREOF, this Subscription Agreement has been executed by
the undersigned on the ________________ day of _____________________, 2000.
OR
- ------------------------------- ----------------------------------------
Individual Investor Signature Entity (Print name of entity)
By:
-------------------------------------
Print Name:
-----------------------------
Title:
----------------------------------
------------------------------------------
Name desired on company records
------------------------------------------
Address
------------------------------------------
City, State Zip Code
-----------------------
Social Security or Tax I.D.#
- -------------------------------------------------------------------------------
ACCEPTANCE BY CORNERSTONE
This Subscription Agreement is hereby accepted on behalf of
Cornerstone Bancshares, Inc.
Date: , 2000 CORNERSTONE BANCSHARES, INC.
----------------
By:
----------------------------------------
Title:
-------------------------------------
<PAGE> 76
CORNERSTONE BANCSHARES, INC.
<PAGE> 77
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 1. INDEMNIFICATION OF OFFICERS AND DIRECTORS.
Our Charter and Bylaws provide for the indemnification of the
Company's directors, officers, employees and agents to the full extent
permitted by the Tennessee Business Corporation Act ("TBCA").
Indemnification may be provided by Cornerstone upon court order or
upon a determination by (1) a disinterested majority of our Board of Directors;
(2) independent legal counsel in a written opinion; or (3) a majority of our
shareholders that indemnification of the director, officer, employee or agent
is proper because such person met the applicable standard of conduct specified
by the TBCA and our Charter and Bylaws. Indemnification may be authorized if
the individual (1) acted in good faith; (2) reasonably believed that his
conduct was in or not opposed to the best interest of the corporation; and (3)
in the case of any criminal proceeding, had no reasonable cause to believe his
conduct was unlawful. The termination of any action, suit or proceeding by
judgment, order, settlement, conviction, or plea of nolo contendere or its
equivalent, shall not, of itself, create a presumption that the above standard
of conduct has not been met. To the maximum extent permitted by Tennessee law,
no director can be held personally liable to Cornerstone for monetary damages
for any breach of his fiduciary duty to the corporation; provided that, a
director may be liable (1) for breach of the director's duty of loyalty to
Cornerstone and its shareholders; (2) for acts or omission not in good faith or
involving intentional misconduct or a knowing violation of law; or (3) for any
liability under Section 48-18-304 of the Tennessee Business Corporation Act.
The TBCA provides that Cornerstone may not indemnify a director in
connection with any action, suit or proceeding in which a judgement or other
final adjudication established the director's liability (1) for a breach of the
duty of loyalty to Cornerstone or its shareholders; (2) for acts or omissions
not in good faith or which involve intentional misconduct or a knowing
violation of law; or (3) for unlawful distributions pursuant to TBCA Section
48-18-304.
In addition, the TBCA and Cornerstone's Charter and Bylaws authorize
us to purchase officer and director liability insurance. We have purchased
officer and director liability insurance.
ITEM 2. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The estimated expenses in connection with this offering are as set
forth in the following table. All amounts except the SEC registration fee are
estimated.
<TABLE>
<S> <C>
SEC Registration Fee $ 1,663
Printing and Engraving Expenses 4,000
Accounting Fees and Expenses 8,000
Legal Fees and Expenses 20,000
Miscellaneous 1,337
-------
Total $35,000
=======
</TABLE>
ITEM 3. UNDERTAKINGS.
(a) The undersigned Registrant hereby undertakes to file, during
any period in which the Registrant offers or sells securities, a post-effective
amendment to this registration statement (1) to include any prospectus required
by section 10(a)(3) of the Securities Act of 1933; (2) to reflect in the
prospectus any facts or events which, individually or together, represent a
fundamental change in the information in the registration statement;
notwithstanding the foregoing, any increase or decrease in the volume of
securities offered (if the total dollar value would not exceed that which was
registered) and any deviation from the low or high end of the estimated maximum
offering range may be reflected in the form of prospectus filed with the
Securities and Exchange Commission pursuant to Rule 424(b) if, in the
aggregate, the changes in the volume and price represent no more than a 20%
change in the
II-1
<PAGE> 78
maximum aggregate offering price set forth in the "Calculation of Registration
Fee" table in the effective registration statement; and (3) to include any
additional or changed material information on the plan of distribution.
(b) For determining liability under the Securities Act of 1933,
the undersigned Registrant hereby undertakes to treat each post-effective
amendment as a new registration statement of the securities offered, and the
offering of the securities at that time to be the initial bona fide offering.
(c) The undersigned Registrant hereby undertakes to file a
post-effective amendment to remove from registration any of the securities that
remain unsold at the end of the offering.
(d) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officer and controlling
persons of the Registrant pursuant to the foregoing provisions, or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
ITEM 4. RECENT SALES OF UNREGISTERED SECURITIES.
None.
ITEMS 5 AND 6. INDEX AND DESCRIPTION OF EXHIBITS
The following exhibits are filed as part of this Registration
Statement.
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
3.1* Charter of Cornerstone Bancshares, Inc.
3.2* Bylaws of Cornerstone Bancshares, Inc.
5 Opinion and Consent of Baker, Donelson, Bearman & Caldwell
as to the validity of the common stock registered hereunder.
10.1 Cornerstone Statutory-Nonstatutory Stock Option Plan
10.2 Employment Agreement between Cornerstone Bancshares, Inc. and
Gregory B. Jones, dated March 1, 1999.
10.3 Employment Agreement between Cornerstone Bancshares, Inc. and
Nathaniel F. Hughes, dated March 1, 1999.
10.4 Employment Agreement between Cornerstone Bancshares, Inc. and
Jerry D. Lee, dated March 1, 1999.
23.1 Consent of Baker, Donelson, Bearman & Caldwell (contained in
Exhibit 5).
23.2 Consent of Hazlett, Lewis & Bieter, PLLC
24 Powers of Attorney (included on signature page)
99.1 Form of Subscription Agreement (included in prospectus)
</TABLE>
- ---------
* Incorporated herein by reference to Registrant's registration
statement on Form S-4 (Registration No. 333-26699), filed on April 8,
1997.
II-2
<PAGE> 79
Pursuant to the requirements of the Securities Act of 1933, the
Registrant has duly caused this Registration Statement on Form S-1 to be signed
on its behalf by the undersigned, thereunto duly authorized in the City of
Chattanooga, State of Tennessee on February 3, 2000.
CORNERSTONE BANCSHARES, INC.
By: /s/ Gregory B. Jones
----------------------------------------
Gregory B. Jones
Chief Executive Officer
By: /s/ Nathaniel F. Hughes
----------------------------------------
Nathaniel F. Hughes
Chief Financial Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below hereby constitute and appoints Gregory B. Jones and Nathaniel F.
Hughes, or either of them, his true and lawful attorney-in-fact and agent, with
full power of substitution and resubstitution, for him and in his name, place
and stead, in any and all capacities, to sign any and all amendments to this
Registration Statement, and to file the same, with all exhibits thereto, and
other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorney-in-fact and agent full power and
authority to do and perform each and every act and thing requisite and
necessary to be done as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorney-in-fact
and agent, or his substitute or substitutes, may lawfully do or cause to be
done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Capacity Date
- --------- -------- ----
<S> <C> <C>
/s/ Gregory B. Jones Chief Executive Officer, President, Director
- -------------------------------- (principal executive officer) January 31, 2000
Gregory B. Jones
/s/ Nathaniel F. Hughes Chief Financial Officer January 31, 2000
- -------------------------------- (principal financial and accounting officer)
Nathaniel F. Hughes
Chairman of the Board January __, 2000
- --------------------------------
Earl A. Marler, Jr
Director January __, 2000
- --------------------------------
Ramesh V. Amin
/s/ Randy Brooks Director January 31, 2000
- --------------------------------
Randy Brooks
/s/ B. Kenneth Driver Director
- --------------------------------
B. Kenneth Driver January 31, 2000
</TABLE>
II-3
<PAGE> 80
<TABLE>
<S> <C> <C>
/s/ Karl Fillauer Director January 31, 2000
- --------------------------------
Karl Fillauer
/s/ Carolyn C. Johnson Executive Vice President, Director January 31, 2000
- --------------------------------
Carolyn C. Johnson
Director January __, 2000
- --------------------------------
James H. Large
Director January __, 2000
- --------------------------------
Lawrence D. Levine
/s/ Russell W. Lloyd Director January 31, 2000
- --------------------------------
Russell W. Lloyd
/s/ Doyce G. Payne Director January 31, 2000
- --------------------------------
Doyce G. Payne, M.D.
/s/ Turner Smith Director January 31, 2000
- --------------------------------
Turner Smith
Director January __, 2000
- --------------------------------
Billy O. Wiggins
/s/ Marsha Yessick Director January 31, 2000
- --------------------------------
Marsha Yessick
</TABLE>
II-4
<PAGE> 1
EXHIBIT 5
Baker Donelson Bearman & Caldwell
SunTrust Building, Suite 300
207 Mockingbird Lane
Johnson City, Tennessee 37604
January 27, 2000
Board of Directors
Cornerstone Bancshares, Inc.
5319 Highway 153
Chattanooga, TN 37343
RE: Registration Statement on Form S-1
Filed January 27, 2000
File No. 333-______
Dear Board of Directors:
We have acted as counsel to Cornerstone Bancshares, Inc., a Tennessee
corporation (the "Company"), in connection with the registration of 150,000
shares of common stock (the "Common Stock") of the Company. The Company has
filed a Registration Statement on Form S-1 pursuant to the Securities Act of
1933, as amended (the "Registration Statement").
We have acted as counsel for the Company in connection with the
proposed transaction and have assisted with the preparation of the Registration
Statement and various corporate documents related thereto. We have examined and
relied upon the following documents and instruments for the purpose of giving
this opinion, which, to our knowledge and in our judgment, are all of the
documents and instruments that are necessary for us to examine for such
purpose:
1. The Registration Statement, the prospectus filed therewith
(the "Prospectus") and all exhibits thereto;
2. A copy of the Company's Charter certified by the Tennessee
Secretary of State;
3. A copy of the Company's Bylaws certified by the Secretary of
the Company;
4. The minute book of the Company; and
5. The stock records of the Company.
In giving our opinion, we have assumed without investigation the
authenticity of any document or instrument submitted to us as an original, the
conformity to the authentic original of any document or instrument submitted to
us as a certified, conformed or photostatic copy and the genuineness of all
signatures on such originals or copies.
Based upon the foregoing and having regard for such legal
considerations as we deem relevant, we are of the opinion that (i) the Company
is a corporation duly incorporated and validly existing under the laws of the
State of
<PAGE> 2
Tennessee and (ii) the Common Stock, when issued in accordance with the
Registration Statement, will be validly issued, fully paid and nonassessable.
Our opinion is subject to the following qualifications and
limitations:
a. The opinions expressed herein are subject to the effect of
applicable bankruptcy, insolvency, reorganization or similar
laws affecting the enforcement of creditors' rights and
equitable principles limiting the availability of equitable
remedies on the enforceability of contracts, agreements and
instruments.
b. Members of our firm are qualified to practice law in the
State of Tennessee and nothing contained herein shall be
deemed to be an opinion as to any law, rule or regulation
other than the law of the State of Tennessee and the federal
law of the United States.
c. The opinions set forth herein are expressed as of the date
hereof and, except during the time prior to the effectiveness
of the Registration Statement filed with the Securities and
Exchange Commission, we disclaim any undertaking to advise
you of any changes which may subsequently be brought to our
attention in the facts and the law upon which such opinions
are based.
This opinion is intended to be used as an exhibit to the Registration
Statement filed with the Securities and Exchange Commission. Except for you and
the purchasers of the securities offered pursuant to the Registration
Statement, neither this opinion nor copies hereof may be relied upon by,
delivered to, or quoted in whole or in part without our prior written consent.
We consent to the reference of our firm name under the caption "Legal
Matters" in the Prospectus and to the use of our opinion as an exhibit to the
Registration Statement. In giving these consents, we do not admit that we come
within the category of persons whose consent is required under Section 7 of the
Securities Act of 1933, as amended, or the rules and regulations of the
Securities and Exchange Commission thereunder.
Very truly yours,
Linda M. Crouch
Baker, Donelson, Bearman & Caldwell
<PAGE> 1
EXHIBIT 10.1
CORNERSTONE BANCSHARES, INC.
STATUTORY-NONSTATUTORY STOCK OPTION PLAN
1. Purpose. The purpose of this Cornerstone Bancshares, Inc.
Statutory-Nonstatutory Stock Option Plan (the "Plan") is to motivate
Participants (as defined herein), thereby benefiting the stockholders
Cornerstone Bancshares, Inc., a Tennessee corporation ("Bancshares"). In
furtherance of this purpose, the Plan is to advance the interests of Bancshares
by stimulating the efforts of key employees, increasing their desire to continue
in their employment with Bancshares, assisting Bancshares in competing
effectively with other enterprises for the services of new employees and
directors necessary for the continued improvement of operations, and to attract
and retain the best possible personnel for service as employees, officers and
directors of Bancshares. Accordingly, the Plan is designed to promote the
interests of Bancshares and its stockholders, and, by facilitating stock
ownership on the part of such directors, officers and employees, to encourage
them to acquire a proprietary interest in Bancshares and to remain in its employ
and service.
2. Definitions.
"Board" means the Board of Directors of Bancshares or its
affiliate(s).
"Code" means the Internal Revenue Code of 1986, as amended.
"Committee" means the Committee(s) chosen by the Board to administer
the Plan, as provided in Section 5(a) hereof.
"Fair Market Value of Stock" shall be determined under the Plan as
follows:
(a) If the Stock is principally traded on an exchange or market in
which prices are reported on a bid and asked basis, the average of the mean
between the bid and the asked price for the Stock at the close of trading for
the 10 consecutive trading days immediately preceding such given date;
(b) If the Stock is principally listed on a national securities
exchange, the average of the closing prices of the Stock for the 10 consecutive
trading days immediately preceding such given date; and
(c) If the Stock is neither traded on the over-the-counter market
nor listed on a national securities exchange, the book value at the close of
business in the preceding month shall determine the fair market value of Stock.
"Incentive Stock Option" has the meaning ascribed in Section 422 of
the Code.
"Non-Qualified Stock Option" means all Options which do not qualify
as Incentive Stock Options such as those granted to non-employee directors.
<PAGE> 2
"Option" means an award of an Incentive Stock Option or
Non-Qualified Stock Option pursuant to this Plan.
"Option Agreement" means the written instrument from the Committee
to Participant describing the terms of the Option.
"Option Price" means the exercise price of an Option.
"Option Stock" or "Stock" means the common stock of Bancshares.
"Participant" means a person to whom an Option has been granted.
3. Effective Date of Plan; Term. The Plan is effective October 15,
1997, the effective date on which the Board and stockholders of Bancshares
approved the Plan. No Options intended to be Incentive Stock Options may be
granted after January 25, 2006.
4. Shares Subject to the Plan. The aggregate number of shares of Stock
available for grant under the Plan is 205,000, subject to adjustments as
provided in Section 9 herein. Of such shares, 55,000 are allocated to the
Options which are Incentive Stock Options and the remaining 150,000 shares of
Stock are allocated to Options which are Non-Qualified Stock Options. Stock
issued pursuant to the Plan may be either authorized but unissued shares or
shares held in the treasury of Bancshares. In the event that, prior to the end
of the period during which Options may be granted under the Plan, any Option
under the Plan expires unexercised or is terminated or surrendered without being
exercised, in whole or in part, the number of shares theretofore subject to such
Option or the unexercised or terminated portion thereof, shall be added to the
remaining number of shares of Stock available for grant as an Option under the
Plan, including a grant to a former holder of such Option, upon such terms and
conditions as the Committee shall determine, which terms may be more or less
favorable than those applicable to such former Option.
5. Administration of the Plan by the Committee.
(a) The Committee. The Plan shall be administered by the Committee,
whose members shall be appointed from time to time by, and shall serve at the
pleasure of, the Board. The members of the Committee need not be members of the
Board or employees of Bancshares. The Board, in its discretion, may appoint
separate committees to administer the Incentive Stock Options and the
Non-Qualified Stock Options. No member of the Committee shall be liable for any
action taken, or determination made, hereunder in good faith. Service on the
Committee shall be entitled to indemnification and reimbursement as directors of
Bancshares pursuant to its Charter and Bylaws. The Committee may take action
only upon the agreement of a majority of the entire Committee. Any action which
the Committee takes through a written instrument signed by a majority of its
members shall be as effective as though taken at a meeting duly called and held.
<PAGE> 3
(b) Powers of the Committee. Subject to the express provisions of
the Plan, the Committee may interpret the Plan, prescribe, amend and rescind
rules and regulations relating to it and make all determinations it deems
necessary or advisable for the administration of the Plan. The powers of the
Committee shall include plenary authority to administer and interpret the Plan,
and subject to the provisions hereof, to determine the persons to whom Options
shall be granted, the number of shares subject to each Option, the terms and
provisions of each Option, and the date on which Options shall be granted. In
making such determinations, the Committee may take into account the nature of
the services rendered by such Participants, or classes of Participants, their
present and potential contributions to Bancshares' success and such other
factors as the Committee, in its discretion, shall deem relevant. Any
interpretation of Options intended to be Incentive Stock Options shall be made
in such a manner that they continue to be Incentive Stock Options. Accordingly,
the Committee shall determine, as soon as practicable after the effective date
of the Plan and at any time and from time to time thereafter, (i) the persons
who are eligible, (ii) the number of shares of Stock which an eligible person
may purchase pursuant to an Option, (iii) the price of each share of Stock
subject to the Option and (iv) the terms on which each share of Stock subject to
the Option may be purchased.
(c) Conclusiveness of Determinations. Any action taken by the
Committee or by the Board with respect to the implementation, interpretation, or
administration of the Plan shall be final, conclusive and binding. The
Committee's determinations under the Plan, including, without limitation,
determinations as to the persons to receive awards, the terms and provisions of
such awards and the agreements evidencing the same, need not be uniform and may
be made by it selectively among persons who receive or are eligible to receive
awards under the Plan, whether of not such persons are similarly situated.
6. Options.
(a) Grant of Options. Incentive Stock Options and Non-Qualified
Stock Options may be granted under the Plan by the Committee for the purchase of
Stock. Options shall be subject to such terms and conditions, shall be
exercisable at such times, and shall be evidenced by such form of written option
agreement between Participant and Bancshares, as the Committee shall determine;
provided, that such determinations are no inconsistent with the other provisions
of the Plan. The Committee shall have authority to grant Options exercisable in
whole or in part at any time during their term. Option Agreements need not be
identical.
(b) Restrictions on the Grant of Incentive Stock Options. No Option
intended to be an Incentive Stock Option shall be granted to any person owning,
within the meaning of Sections 422 and 424 of the Code, Stock of Bancshares
possessing more than ten percent (10%) of the total combined voting power of all
classes of stock of Bancshares unless the provisions of Section 7(a) and (b)
hereof are complied with. In any one calendar year, no individual shall receive
Options to purchase Stock under any plan of Bank intended to be Incentive Stock
Options to the extent that the Stock subject
<PAGE> 4
to such Options exercisable for the first time by an individual during any
calendar year has an aggregate Fair Market Value (determined at the time the
Options are granted) in excess of $100,000.
(c) Persons Eligible to Receive Options. The persons who shall be
eligible to receive Options granted hereunder intended to be Incentive Stock
Options shall be those key employees and officers of Bancshares who are selected
by the Committee from time to time. Persons designated by the Committee who are
eligible to receive Non-Qualified Options hereunder need not be employees of
Bancshares, and generally will be non-employee directors or advisory directors
of Bancshares or its affiliate(s). A Participant may hold more than one Option.
The Committee shall determine the terms for payment by each Participant for his
shares of Option Stock. Such terms shall be set forth in the Option Agreement.
The terms for payment so set by the Committee may vary from one Participant to
another.
7. Terms and Exercise of Options.
(a) Option Price. The Option Price to be paid by Participant to
Bancshares upon exercise of the Option shall be determined by the Committee on
the date of the grant of the Option and shall be set forth in the Option
Agreement. No Option shall have an Option Price less than the greater of the
Original Issue Price or the Fair Market Value of the Stock on the date of the
grant. If any Option intended to be an Incentive Stock Option is granted to any
person holding Stock possessing more than ten percent (10%) of the total
combined voting power of all classes of stock of Bancshares, the Option Price
shall be not less than one hundred ten percent (110%) of the Fair Market Value
of the Stock on the date of the grant.
(b) Term. Each Option granted under the Plan shall be exercisable
only during a term commencing on the date when the Option was granted and ending
(unless the Option shall have terminated earlier under other provisions of the
Plan) on a date to be fixed by the Committee, but not later than ten (10) years
from the date of grant in the case of any Option intended to be an Incentive
Stock Option, subject to the following limitations:
(i) any Option intended to be an Incentive Stock Option which
is granted to any person possessing more than ten percent (10%) of the
total combined voting power of all classes of stock of Bancshares shall
be exercisable not later than five (5) years from the date of grant;
and
(ii) any Option intended to be an Incentive Stock Option may
not be exercisable more than three (3) months after Participant ceases
to be an employee of Bancshares.
(c) Death or Disability. Upon the death or disability (within the
meaning of Section 22(e)(3) of the Code) of a Participant holding a
Non-Qualified Stock Option, in the absence of terms in the Option Agreement to
the contrary, the Option may be
<PAGE> 5
exercised, to the extent not previously exercised, by Participant's legal
representative, the legatees of the Option under Participant's Will or the
distributees of the Option under the applicable laws of descent and distribution
until the Termination Date, but only to the extent that the Option would
otherwise have been exercisable by Participant. Upon the death of a Participant
holding an Incentive Stock Option, in the absence of terms in the Option
Agreement to the contrary, the Option may be exercised, to the extent not
previously exercised, by Participant's legal representative, the legatees of the
Option under Participant's Will or the distributees of the Option under the
applicable laws of descent and distribution until the Termination Date, but only
to the extent that the Option would otherwise have been exercisable by
Participant. Upon the disability of a Participant holding an Incentive Stock
Option, the Option may be exercised by Participant or Participant's legal
representative, to the extent not previously exercised, until the earlier of the
termination date for such Option or the date occurring one year from the date of
the termination of Participant's employment due to disability.
(d) Exercise of Options. Options shall be exercised by delivering or
mailing to the Committee (i) a notice and "investment letter" in the form
prescribed by the Committee, specifying the number of shares to be purchased;
and (ii) a check payable to Bancshares or such other medium or payment as the
Committee shall approve, in an amount equal to the Option Price plus any
withholding tax required by law as determined by Bancshares. Upon receipt of
each of the foregoing, Bancshares shall promptly deliver to Participant a
certificate or certificates for the Stock purchased, without charge to
Participant for issue in Participant's name and the name of another person as
joint tenants with the right of survivorship, provided that any restrictions
upon such Stock shall apply equally to such joint tenant. In the event that such
shares are not registered under the Securities Act of 1933, such certificates
shall bear the following legend:
THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED
UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR UNDER ANY
STATE SECURITIES ACT ("STATE ACTS"), AND MAY NOT BE SOLD OR OTHERWISE
TRANSFERRED UNLESS SUCH SHARES ARE REGISTERED UNDER SUCH ACT AND EACH
RELEVANT STATE ACT OR AN OPINION OF COUNSEL SATISFACTORY TO BANCSHARES
IS OBTAINED TO THE EFFECT THAT SUCH REGISTRATION IS NOT NECESSARY.
(e) Transferability of Options. No Option may be transferred,
assigned, pledged or hypothecated (whether by operation of law or otherwise),
except that an Option may be transferred upon the death of a Participant as
provided by Participant's Will or the applicable laws of descent or
distribution. No Option shall be subject to execution, attachment or similar
process. Any attempted assignment, transfer, pledge, hypothecation or other
disposition of an Option, or levy of attachment or similar process upon the
Option not specifically permitted herein shall be null and void and without
effect. Notwithstanding the provisions of this Section, a Participant, at any
time prior to his death, may assign all or any portion of a Non-Qualified Stock
Option to (i) his or her spouse or lineal descendant, (ii) the trustee of a
trust for the primary benefit of his or her
<PAGE> 6
spouse and lineal descendant, (iii) a partnership of which his or her spouse and
lineal descendants are the only partners, or (iv) a tax exempt organization as
described in Section 501(c)(3) of the Code. In such event, the permitted
transferee will be entitled to all of the rights of Participant with respect to
the assigned portion of such Non-Qualified Stock Option, and such portion of the
Non-Qualified Stock Option will continue to be subject to all of the terms,
conditions and restrictions applicable to the Option, as set forth herein and in
the related Option Agreement, immediately prior to the effective date of the
assignment. Any such assignment will be permitted only if (i) Participant does
not receive any consideration therefore, and (ii) the assignment is expressly
permitted by the applicable Option Agreement, as approved by the Committee. Any
such assignment shall be evidenced by a written document executed by
Participant, and a copy thereof shall be delivered to Bancshares prior to the
assignment.
(f) Stockholders' Agreement. The exercise of an Option shall be
conditioned upon Participant executing, if so requested by Bancshares, a
Stockholders' Agreement. All Stock issued to a Participant pursuant to an Option
shall be subject to any applicable Stockholders' Agreement previously entered
into by such Participant. Any legend required by any such agreement shall be
placed on the certificates evidencing the Stock.
(g) Obligation to Exercise Option. The granting of an Option shall
impose no obligation upon a Participant to exercise such Option.
8. Participant's Rights. No person shall have the rights of a
stockholder by virtue of an Option except with respect to Stock actually issued
to the stockholder, and issuance of Stock shall confer no retroactive rights to
dividends. Nothing in the Plan or any Option Agreement entered into pursuant to
the Plan shall confer upon any Participant the right to continue as a member of
the Board or affect any right which Bancshares may have to remove such
Participant as a director of Bancshares or its affiliate(s). Nothing in this
Plan or in any Option Agreement shall confer upon any employee any right to
continue in the employ of Bancshares or its affiliate(s) or interfere in any way
with the right of Bancshares or its affiliate(s) to terminate his or her
employment at any time.
9. Adjustments. In the event of the declaration of any stock dividend
on the Stock or in the event of any reorganization, merger, consolidation,
acquisition, separation, recapitalization, split-up, combination or exchange of
shares of Stock, or like adjustment, the number of shares of Stock and the class
of shares of Stock available pursuant to the Plan, and the Option Prices, shall
be adjusted by appropriate changes in the Plan and in any Option Agreement
outstanding pursuant to the Plan. Any such adjustments to the Plan or to Option
Agreements or Option Prices shall be made by action of the Committee, whose
determination shall be conclusive; provided, however, that each Option granted
pursuant to the Plan intended to be an Incentive Stock Option shall be so
adjusted as to continue to qualify as an Incentive Stock Option. Notwithstanding
the foregoing, in the event of such a reorganization, merger, consolidation,
acquisition, separation, recapitalization, split-up, combination or exchange of
shares of stock, or like adjustment which results in substantially all the
shares of the Stock of Bancshares being exchanged for, or converted into cash or
other property, the
<PAGE> 7
Committee shall have the right to terminate the Plan as of the date of the
exchange or conversion in which case the Options shall convert into the right to
receive such cash or property net of the exercise price of the Options.
10. Termination, Suspension or Amendment of Plan. The Committee may at
any time terminate, suspend or amend the Plan, except that the Committee shall
not, without the authorization of the holders of a majority of the Stock voted
at a stockholders' meeting duly called and held, change any provisions (other
than those adjustments for changes in capitalization as hereinbefore provided)
which determines (a) the aggregate number of shares for which Options may be
granted under the Plan or to any person; (b) the classes of persons eligible for
Options; or (c) the duration of the Plan.
11. Postponement of Exercise. The Committee may postpone any exercise
of an Option for such time as the Committee may deem necessary in order to
permit Bancshares (i) to effect, amend or maintain any necessary registration of
the Plan or the shares of Stock issuable upon the exercise of an Option under
the Securities Act of 1933, as amended, or the securities laws of any applicable
jurisdiction, (ii) to permit any action to be taken in order to (A) list such
shares of Stock on a stock exchange if shares of Stock are then listed on such
exchange or (B) comply with restrictions or regulations incident to the
maintenance of a public market for its shares of Stock, including any rules or
regulations of any stock exchange on which the shares of Stock are listed, or
(iii) to determine that such shares of Stock and the Plan are exempt from such
registration or that no action of the kind referred to in (ii)(B) above need to
be taken; and Bancshares shall not be obligated by virtue of any terms and
conditions of any Option Agreement or any provision of the Plan to recognize the
exercise of an Option or to sell or issue shares of Stock in violation of the
Securities Act of 1933 or the law of any government having jurisdiction thereof.
Any such postponement shall not extend the terms of an Option and neither
Bancshares nor its directors or officers shall have any obligation or liability
to any Participant or to any other person with respect to any shares of Stock as
to which the Option shall lapse because of such postponement.
12. Application of Proceeds. The proceeds received by Bancshares from
the sale of its Stock under the Plan shall be used for general corporate
purposes.
13. Elimination of Fractional Shares. If under any provision of the
Plan that requires a computation of the number of shares of Stock subject to an
Option, the number so computed is not a whole number of shares of Stock, such
number of shares of Stock shall be rounded down to the next whole number.
14. Validity. In the event that any provision of the Plan or any
related agreement is held to be invalid, void or unenforceable, the Board shall
have the right to declare the entire Plan void and unenforceable, taking such
action as shall be deemed to be in the best interest of the stockholders of
Bancshares.
15. Titles. Titles are provided herein for convenience only and are not
to serve as a basis for interpretation or construction of the Plan.
<PAGE> 8
16. Governing Law. All questions pertaining to the validity,
construction and administration of the Plan and Options granted hereunder shall
be determined in conformity with the laws of the State of Tennessee.
<PAGE> 1
EXHIBIT 10.2
KEY EXECUTIVE EMPLOYMENT AND SEVERANCE AGREEMENT
This agreement, made and entered into as of this 1st day of March, 1999, by and
between Cornerstone Community Bank, Inc., a Tennessee chartered state bank,
(the "Bank"), which is a 100% wholly owned affiliate of Cornerstone Bancshares,
Inc., (the "Company"), and Gregory B. Jones (the "Executive").
WHEREAS, the Executive has been employed by the Bank as an executive officer,
and the Bank enters into this agreement as additional incentive to the
Executive to continue as an executive employee of the Bank; and,
WHEREAS, the parties desire by this written agreement to set forth their
understanding as to their respective rights and obligations in the event of a
Change-in-Control with respect to the Bank or the Company.
NOW, THEREFORE, the undersigned parties agree as follows:
1. Definitions:
a. Change-in-Control of the Bank or Company. A Change-in-Control
occurs when:
(i) The shareholders of the Bank or the Company approve
a merger or consolidation of either entity with any
other entity as a result of which less than 50% of
the outstanding voting securities of the surviving
entity are owned by the former shareholders of the
Bank or the Company; or,
(ii) The shareholders of the Company approve the sale of
substantially all of the Bank's assets to an entity
that is not a wholly owned affiliate of the Company.
b. Code. The term "Code" means the Internal Revenue Code of
1986, as amended.
c. Merger Agreement. The "Merger Agreement" means that agreement
entered into by the Bank or the Company and the Negotiating
Successor Entity defining the terms, conditions, rights,
warranties and responsibilities of the entities involved in
the proposed merger or consolidation. The "Merger Agreement"
must be approved by the Board of Directors of the Bank or the
Company prior to the date of the Change-in-Control.
d. Negotiating Successor Entity. The "Negotiating Successor
Entity" is the entity expected to be the surviving entity
subsequent to the date of the Change-in-Control, as defined
above, excluding affiliates of the Bank or the Company.
e. Termination Date. Except as otherwise provided the term
"Termination Date" means the date the Executive's employment
is terminated.
2. Term of Agreement. This agreement shall be effective as of this 1st
day of March, 1999, and continue for the term of three (3) years,
which term may be extended for additional periods or cancelled as
determined by the Board of Directors of the Bank or the Company. If
this agreement should expire within nine (9) months of the date of
Change-in-Control, then this agreement shall automatically be extended
to the date of Change-in-Control.
3. Continuation of Employment. As a precondition of any Merger Agreement,
Company or Bank shall require the Negotiating Successor Entity to
negotiate with the Executive. The Executive has an obligation to
negotiate with the Negotiating Successor Entity and accept a position,
if a position of executive status in the Chattanooga area is offered,
and this offer is documented by a continuing employee agreement ("the
Employment Agreement"). Executive status is defined as Vice President
level or above. The Employment Agreement will define among other
things, but not be limited to, salary, title, responsibilities,
employment location, employment benefits, death benefits, disability
benefits, expense and interest with respect to enforcement of the
Employment Agreement, non-compete definitions, definitions of "Cause"
for termination by the Negotiating Successor Entity and definitions of
"Good Reason" for termination by the Executive. The terms as agreed to
by the Executive and the Negotiating Successor Entity will be included
in the Merger Agreement. It is the intention of this agreement that
the terms of the Employment Agreement be included in the Merger
Agreement or incorporated by reference prior to the final approval by
the Board of Directors of the
<PAGE> 2
Bank or the Company of the Merger Agreement. If an Employment
Agreement is finalized between the Executive and the Negotiating
Successor Entity, it must include at a minimum the following items:
a. The Executive shall receive an Employment Agreement for two
years from the date of the Change-in-Control;
b. The Executive shall receive an annual salary not less than
100% of the Executive's aggregated annual base compensation
as in effect as of the date of the Change-in-Control;
c. The Executive shall be reimbursed, according to standard
policies in effect on the date of the Change-in-Control, for
any and all reasonable and necessary expenses incurred by the
Executive on behalf of the Bank, the Company or the
Negotiating Successor Entity including, but not limited to,
travel expenses;
d. The Executive shall be included in any and all benefit plans
providing general benefits for the employees, including, but
not limited to, group life insurance, medical insurance,
dental insurance, long-term disability insurance, pension,
profit-sharing. The Executive shall be provided any and all
other benefits and perquisites made available to other
employees of comparable status and position offered by the
Negotiating Successor Entity;
e. The Executive shall receive annually not less than the amount
of paid vacation and holidays received annually on the date
of the Change-in-Control, or such amount of paid vacation and
holidays as may be made available to other employees of
comparable status and position; and,
f. The Executive shall be included in all plans providing
special benefits to other employees of comparable status and
position, including but not limited to, profit-sharing,
bonus, deferred compensation, incentive compensation, stock
options.
4. Payment Upon Termination. If the Negotiating Successor Entity does not
offer the Executive an Employment Agreement in accordance with
paragraph 3 above, the following will be the terms for a Payment upon
Termination due to the Executive:
(i) All salary earned or accrued but not yet paid
through the Termination Date;
(ii) Reimbursement for any and all expenses incurred by
the Executive on behalf of the Bank, the Company or
the Negotiating Successor Entity, but not yet paid,
through the Termination Date;
(iii) Any and all cash benefits previously earned, but not
yet paid, including any deferred compensation,
accrued pension, bonus or incentive compensation
through the Termination Date;
(iv) All other payments and benefits to which the
Executive may be entitled under the terms of any
benefit plan of the Bank or the Company;
(v) All incentive stock options, restricted stock and
stock appreciation rights to which the Executive may
be entitled will become immediately vested at 100%;
and,
(vi) A lump sum payment, equal to two (2) times the
Executive's annualized base compensation then in
effect at the Termination Date.
a. If the Negotiating Successor Entity and the Executive fail to
reach an understanding on the terms and conditions of the
Employment Agreement because the Executive does not negotiate
in "Good-Faith", the Executive's termination date will be the
date of Change-in-Control. The Payment Upon Termination will
include items 3(i) to 3(iv) from above. "Good Faith" shall
mean the Executive should negotiate with the Negotiating
Successor Entity for an Employment Agreement with similar
terms and conditions as are applicable at the Bank or Company
on the date immediately preceding the Change-in-Control.
b. It is the intention of the Bank and the Company that no
portion of the Payment Upon Termination be deemed to be a
parachute payment as defined in Section 280G(b)(2) of the
Code, as amended. The Payment Upon Termination shall not
exceed the maximum limit imposed by Section 4999 of the Code,
as amended.
c. The Payment upon Termination will be paid in full by the 15th
day following the Termination Date.
<PAGE> 3
d. It is the intention of this agreement that the terms of the
Payment Upon Termination be included in the Merger Agreement
prior to the final approval by the Board of Directors of the
Bank or the Company of the Merger Agreement.
5. Non-competition. In the event of payment pursuant to paragraph 4, for
(1) year following the Termination Date the executive agrees not to
become engaged in any business or activities within the Chattanooga
Standard Metropolitan Statistical Area, which is directly or
indirectly in competition with any business or activity engaged in by
the Negotiating Successor Entity.
6. Enforcement. The provisions of this agreement shall be regarded as
divisible, and if any of said provisions or any parts of any
provisions are declared invalid or unenforceable by a court of
competent jurisdiction, the validity and enforceability of the
remaining agreement shall not be affected.
7. Amendment or Cancellation. The Bank or the Company shall retain the
right to terminate the employment of the Executive at any time for
sufficient cause. This agreement may not be amended, modified or
cancelled within nine (9) months of the date of Change-in-Control
except by written instrument executed by the Bank and the Executive.
8. Venue and Governing Law. This agreement and the rights and obligations
hereunder shall be governed by and construed in accordance with the
laws of the State of Tennessee. Any action concerning this agreement
shall be brought in the federal or state courts located in the County
of Hamilton, Tennessee, and each party consents to the venue and
jurisdiction of such courts.
9. Notice. Notices given pursuant to this agreement shall be in writing
and shall be deemed given when received and if mailed, shall be mailed
by United States registered or certified mail, if to the Bank or the
Company, to:
Cornerstone Community Bank
5319 Highway 153
Hixson, TN 37343
or if to the Executive, at the address set forth below the Executive's
signature line of this agreement.
10. No Waiver. No waiver by either party at any time of any breach by the
other party of, or compliance with, any condition or provision of this
agreement to be performed by the other party shall be deemed a waiver
of similar or dissimilar provisions or conditions at the same time or
any prior or subsequent time.
11. Company Consent. This agreement is conditioned upon the consent of the
Company and the Company's agreement to implement those provisions of
the agreement over which it has control.
12. Headings. The headings herein contained are for reference only and
shall not affect the meaning or interpretation of any provision of
this agreement.
13. Entire Agreement. This agreement expresses the entire agreement of the
parties with respect to the subject matter hereof.
<PAGE> 4
IN WITNESS WHEREOF, the parties have executed this agreement as of the day and
year first written above.
CORNERSTONE COMMUNITY BANK
EXECUTIVE:
By: Gregory B. Jones
----------------------------------
Title: Chief Executive Officer and
President
<PAGE> 1
EXHIBIT 10.3
KEY EXECUTIVE EMPLOYMENT AND SEVERANCE AGREEMENT
This agreement, made and entered into as of this 1st day of March, 1999, by and
between Cornerstone Community Bank, Inc., a Tennessee chartered state bank,
(the "Bank"), which is a 100% wholly owned affiliate of Cornerstone Bancshares,
Inc., (the "Company"), and Nathaniel Francis (Frank) Hughes (the "Executive").
WHEREAS, the Executive has been employed by the Bank as an executive officer,
and the Bank enters into this agreement as additional incentive to the
Executive to continue as an executive employee of the Bank; and,
WHEREAS, the parties desire by this written agreement to set forth their
understanding as to their respective rights and obligations in the event of a
Change-in-Control with respect to the Bank or the Company.
NOW, THEREFORE, the undersigned parties agree as follows:
1. Definitions:
a. Change-in-Control of the Bank or Company. A Change-in-Control
occurs when:
(i) The shareholders of the Bank or the Company approve
a merger or consolidation of either entity with any
other entity as a result of which less than 50% of
the outstanding voting securities of the surviving
entity are owned by the former shareholders of the
Bank or the Company; or,
(ii) The shareholders of the Company approve the sale of
substantially all of the Bank's assets to an entity
that is not a wholly owned affiliate of the Company.
b. Code. The term "Code" means the Internal Revenue Code of
1986, as amended.
c. Merger Agreement. The "Merger Agreement" means that agreement
entered into by the Bank or the Company and the Negotiating
Successor Entity defining the terms, conditions, rights,
warranties and responsibilities of the entities involved in
the proposed merger or consolidation. The "Merger Agreement"
must be approved by the Board of Directors of the Bank or the
Company prior to the date of the Change-in-Control.
d. Negotiating Successor Entity. The "Negotiating Successor
Entity" is the entity expected to be the surviving entity
subsequent to the date of the Change-in-Control, as defined
above, excluding affiliates of the Bank or the Company.
e. Termination Date. Except as otherwise provided the term
"Termination Date" means the date the Executive's employment
is terminated.
2. Term of Agreement. This agreement shall be effective as of this 1st
day of March, 1999, and continue for the term of three (3) years,
which term may be extended for additional periods or cancelled as
determined by the Board of Directors of the Bank or the Company. If
this agreement should expire within nine (9) months of the date of
Change-in-Control, then this agreement shall automatically be extended
to the date of Change-in-Control.
3. Continuation of Employment. As a precondition of any Merger Agreement,
Company or Bank shall require the Negotiating Successor Entity to
negotiate with the Executive. The Executive has an obligation to
negotiate with the Negotiating Successor Entity and accept a position,
if a position of executive status in the Chattanooga area is offered,
and this offer is documented by a continuing employee agreement ("the
Employment Agreement"). Executive status is defined as Vice President
level or above. The Employment Agreement will define among other
things, but not be limited to, salary, title, responsibilities,
employment location, employment benefits, death benefits, disability
benefits, expense and interest with respect to enforcement of the
Employment Agreement, non-compete definitions, definitions of "Cause"
for termination by the Negotiating Successor Entity and definitions of
"Good Reason" for termination by the Executive. The terms as agreed to
by the Executive and the Negotiating Successor Entity will be included
in the Merger Agreement. It is the intention of this agreement that
the terms of the Employment Agreement be included in the Merger
Agreement or incorporated by reference prior to the final approval by
the Board of Directors of the
<PAGE> 2
Bank or the Company of the Merger Agreement. If an Employment
Agreement is finalized between the Executive and the Negotiating
Successor Entity, it must include at a minimum the following items:
a. The Executive shall receive an Employment Agreement for two
years from the date of the Change-in-Control;
b. The Executive shall receive an annual salary not less than
100% of the Executive's aggregated annual base compensation
as in effect as of the date of the Change-in-Control;
c. The Executive shall be reimbursed, according to standard
policies in effect on the date of the Change-in-Control, for
any and all reasonable and necessary expenses incurred by the
Executive on behalf of the Bank, the Company or the
Negotiating Successor Entity including, but not limited to,
travel expenses;
d. The Executive shall be included in any and all benefit plans
providing general benefits for the employees, including, but
not limited to, group life insurance, medical insurance,
dental insurance, long-term disability insurance, pension,
profit-sharing. The Executive shall be provided any and all
other benefits and perquisites made available to other
employees of comparable status and position offered by the
Negotiating Successor Entity;
e. The Executive shall receive annually not less than the amount
of paid vacation and holidays received annually on the date
of the Change-in-Control, or such amount of paid vacation and
holidays as may be made available to other employees of
comparable status and position; and,
f. The Executive shall be included in all plans providing
special benefits to other employees of comparable status and
position, including but not limited to, profit-sharing,
bonus, deferred compensation, incentive compensation, stock
options.
4. Payment Upon Termination. If the Negotiating Successor Entity does not
offer the Executive an Employment Agreement in accordance with
paragraph 3 above, the following will be the terms for a Payment upon
Termination due to the Executive:
(i) All salary earned or accrued but not yet paid
through the Termination Date;
(ii) Reimbursement for any and all expenses incurred by
the Executive on behalf of the Bank, the Company or
the Negotiating Successor Entity, but not yet paid,
through the Termination Date;
(iii) Any and all cash benefits previously earned, but not
yet paid, including any deferred compensation,
accrued pension, bonus or incentive compensation
through the Termination Date;
(iv) All other payments and benefits to which the
Executive may be entitled under the terms of any
benefit plan of the Bank or the Company;
(v) All incentive stock options, restricted stock and
stock appreciation rights to which the Executive may
be entitled will become immediately vested at 100%;
and,
(vi) A lump sum payment, equal to two (2) times the
Executive's annualized base compensation then in
effect at the Termination Date.
a. If the Negotiating Successor Entity and the Executive fail to
reach an understanding on the terms and conditions of the
Employment Agreement because the Executive does not negotiate
in "Good-Faith", the Executive's termination date will be the
date of Change-in-Control. The Payment Upon Termination will
include items 3(i) to 3(iv) from above. "Good Faith" shall
mean the Executive should negotiate with the Negotiating
Successor Entity for an Employment Agreement with similar
terms and conditions as are applicable at the Bank or Company
on the date immediately preceding the Change-in-Control.
b. It is the intention of the Bank and the Company that no
portion of the Payment Upon Termination be deemed to be a
parachute payment as defined in Section 280G(b)(2) of the
Code, as amended. The Payment Upon Termination shall not
exceed the maximum limit imposed by Section 4999 of the Code,
as amended.
c. The Payment upon Termination will be paid in full by the 15th
day following the Termination Date.
<PAGE> 3
d. It is the intention of this agreement that the terms of the
Payment Upon Termination be included in the Merger Agreement
prior to the final approval by the Board of Directors of the
Bank or the Company of the Merger Agreement.
5. Non-competition. In the event of payment pursuant to paragraph 4, for
(1) year following the Termination Date the executive agrees not to
become engaged in any business or activities within the Chattanooga
Standard Metropolitan Statistical Area, which is directly or
indirectly in competition with any business or activity engaged in by
the Negotiating Successor Entity.
6. Enforcement. The provisions of this agreement shall be regarded as
divisible, and if any of said provisions or any parts of any
provisions are declared invalid or unenforceable by a court of
competent jurisdiction, the validity and enforceability of the
remaining agreement shall not be affected.
7. Amendment or Cancellation. The Bank or the Company shall retain the
right to terminate the employment of the Executive at any time for
sufficient cause. This agreement may not be amended, modified or
cancelled within nine (9) months of the date of Change-in-Control
except by written instrument executed by the Bank and the Executive.
8. Venue and Governing Law. This agreement and the rights and obligations
hereunder shall be governed by and construed in accordance with the
laws of the State of Tennessee. Any action concerning this agreement
shall be brought in the federal or state courts located in the County
of Hamilton, Tennessee, and each party consents to the venue and
jurisdiction of such courts.
9. Notice. Notices given pursuant to this agreement shall be in writing
and shall be deemed given when received and if mailed, shall be mailed
by United States registered or certified mail, if to the Bank or the
Company, to:
Cornerstone Community Bank
5319 Highway 153
Hixson, TN 37343
or if to the Executive, at the address set forth below the Executive's
signature line of this agreement.
10. No Waiver. No waiver by either party at any time of any breach by the
other party of, or compliance with, any condition or provision of this
agreement to be performed by the other party shall be deemed a waiver
of similar or dissimilar provisions or conditions at the same time or
any prior or subsequent time.
11. Company Consent. This agreement is conditioned upon the consent of the
Company and the Company's agreement to implement those provisions of
the agreement over which it has control.
12. Headings. The headings herein contained are for reference only and
shall not affect the meaning or interpretation of any provision of
this agreement.
13. Entire Agreement. This agreement expresses the entire agreement of the
parties with respect to the subject matter hereof.
<PAGE> 4
IN WITNESS WHEREOF, the parties have executed this agreement as of the day and
year first written above.
CORNERSTONE COMMUNITY BANK
EXECUTIVE:
By: Nathaniel Francis Hughes
----------------------------------
Title: Executive Vice President and
Chief Financial Officer
<PAGE> 1
EXHIBIT 10.4
KEY EXECUTIVE EMPLOYMENT AND SEVERANCE AGREEMENT
This agreement, made and entered into as of this 1st day of March, 1999, by and
between Cornerstone Community Bank, Inc., a Tennessee chartered state bank,
(the "Bank"), which is a 100% wholly owned affiliate of Cornerstone Bancshares,
Inc., (the "Company"), and Jerry D. Lee (the "Executive").
WHEREAS, the Executive has been employed by the Bank as an executive officer,
and the Bank enters into this agreement as additional incentive to the
Executive to continue as an executive employee of the Bank; and,
WHEREAS, the parties desire by this written agreement to set forth their
understanding as to their respective rights and obligations in the event of a
Change-in-Control with respect to the Bank or the Company.
NOW, THEREFORE, the undersigned parties agree as follows:
1. Definitions:
a. Change-in-Control of the Bank or Company. A Change-in-Control
occurs when:
(i) The shareholders of the Bank or the Company approve
a merger or consolidation of either entity with any
other entity as a result of which less than 50% of
the outstanding voting securities of the surviving
entity are owned by the former shareholders of the
Bank or the Company; or,
(ii) The shareholders of the Company approve the sale of
substantially all of the Bank's assets to an entity
that is not a wholly owned affiliate of the Company.
b. Code. The term "Code" means the Internal Revenue Code of
1986, as amended.
c. Merger Agreement. The "Merger Agreement" means that agreement
entered into by the Bank or the Company and the Negotiating
Successor Entity defining the terms, conditions, rights,
warranties and responsibilities of the entities involved in
the proposed merger or consolidation. The "Merger Agreement"
must be approved by the Board of Directors of the Bank or the
Company prior to the date of the Change-in-Control.
d. Negotiating Successor Entity. The "Negotiating Successor
Entity" is the entity expected to be the surviving entity
subsequent to the date of the Change-in-Control, as defined
above, excluding affiliates of the Bank or the Company.
e. Termination Date. Except as otherwise provided the term
"Termination Date" means the date the Executive's employment
is terminated.
2. Term of Agreement. This agreement shall be effective as of this 1st
day of March, 1999, and continue for the term of three (3) years,
which term may be extended for additional periods or cancelled as
determined by the Board of Directors of the Bank or the Company. If
this agreement should expire within nine (9) months of the date of
Change-in-Control, then this agreement shall automatically be extended
to the date of Change-in-Control.
3. Continuation of Employment. As a precondition of any Merger Agreement,
Company or Bank shall require the Negotiating Successor Entity to
negotiate with the Executive. The Executive has an obligation to
negotiate with the Negotiating Successor Entity and accept a position,
if a position of executive status in the Chattanooga area is offered,
and this offer is documented by a continuing employee agreement ("the
Employment Agreement"). Executive status is defined as Vice President
level or above. The Employment Agreement will define among other
things, but not be limited to, salary, title, responsibilities,
employment location, employment benefits, death benefits, disability
benefits, expense and interest with respect to enforcement of the
Employment Agreement, non-compete definitions, definitions of "Cause"
for termination by the Negotiating Successor Entity and definitions of
"Good Reason" for termination by the Executive. The terms as agreed to
by the Executive and the Negotiating Successor Entity will be included
in the Merger Agreement. It is the intention of this agreement that
the terms of the Employment Agreement be included in the Merger
Agreement or incorporated by reference prior to the final approval by
the Board of Directors of the
<PAGE> 2
Bank or the Company of the Merger Agreement. If an Employment
Agreement is finalized between the Executive and the Negotiating
Successor Entity, it must include at a minimum the following items:
a. The Executive shall receive an Employment Agreement for two
years from the date of the Change-in-Control;
b. The Executive shall receive an annual salary not less than
100% of the Executive's aggregated annual base compensation
as in effect as of the date of the Change-in-Control;
c. The Executive shall be reimbursed, according to standard
policies in effect on the date of the Change-in-Control, for
any and all reasonable and necessary expenses incurred by the
Executive on behalf of the Bank, the Company or the
Negotiating Successor Entity including, but not limited to,
travel expenses;
d. The Executive shall be included in any and all benefit plans
providing general benefits for the employees, including, but
not limited to, group life insurance, medical insurance,
dental insurance, long-term disability insurance, pension,
profit-sharing. The Executive shall be provided any and all
other benefits and perquisites made available to other
employees of comparable status and position offered by the
Negotiating Successor Entity;
e. The Executive shall receive annually not less than the amount
of paid vacation and holidays received annually on the date
of the Change-in-Control, or such amount of paid vacation and
holidays as may be made available to other employees of
comparable status and position; and,
f. The Executive shall be included in all plans providing
special benefits to other employees of comparable status and
position, including but not limited to, profit-sharing,
bonus, deferred compensation, incentive compensation, stock
options.
4. Payment Upon Termination. If the Negotiating Successor Entity does not
offer the Executive an Employment Agreement in accordance with
paragraph 3 above, the following will be the terms for a Payment upon
Termination due to the Executive:
(i) All salary earned or accrued but not yet paid
through the Termination Date;
(ii) Reimbursement for any and all expenses incurred by
the Executive on behalf of the Bank, the Company or
the Negotiating Successor Entity, but not yet paid,
through the Termination Date;
(iii) Any and all cash benefits previously earned, but not
yet paid, including any deferred compensation,
accrued pension, bonus or incentive compensation
through the Termination Date;
(iv) All other payments and benefits to which the
Executive may be entitled under the terms of any
benefit plan of the Bank or the Company;
(v) All incentive stock options, restricted stock and
stock appreciation rights to which the Executive may
be entitled will become immediately vested at 100%;
and,
(vi) A lump sum payment, equal to two (2) times the
Executive's annualized base compensation then in
effect at the Termination Date.
a. If the Negotiating Successor Entity and the Executive fail to
reach an understanding on the terms and conditions of the
Employment Agreement because the Executive does not negotiate
in "Good-Faith", the Executive's termination date will be the
date of Change-in-Control. The Payment Upon Termination will
include items 3(i) to 3(iv) from above. "Good Faith" shall
mean the Executive should negotiate with the Negotiating
Successor Entity for an Employment Agreement with similar
terms and conditions as are applicable at the Bank or Company
on the date immediately preceding the Change-in-Control.
b. It is the intention of the Bank and the Company that no
portion of the Payment Upon Termination be deemed to be a
parachute payment as defined in Section 280G(b)(2) of the
Code, as amended. The Payment Upon Termination shall not
exceed the maximum limit imposed by Section 4999 of the Code,
as amended.
c. The Payment upon Termination will be paid in full by the 15th
day following the Termination Date.
<PAGE> 3
d. It is the intention of this agreement that the terms of the
Payment Upon Termination be included in the Merger Agreement
prior to the final approval by the Board of Directors of the
Bank or the Company of the Merger Agreement.
5. Non-competition. In the event of payment pursuant to paragraph 4, for
(1) year following the Termination Date the executive agrees not to
become engaged in any business or activities within the Chattanooga
Standard Metropolitan Statistical Area, which is directly or
indirectly in competition with any business or activity engaged in by
the Negotiating Successor Entity.
6. Enforcement. The provisions of this agreement shall be regarded as
divisible, and if any of said provisions or any parts of any
provisions are declared invalid or unenforceable by a court of
competent jurisdiction, the validity and enforceability of the
remaining agreement shall not be affected.
7. Amendment or Cancellation. The Bank or the Company shall retain the
right to terminate the employment of the Executive at any time for
sufficient cause. This agreement may not be amended, modified or
cancelled within nine (9) months of the date of Change-in-Control
except by written instrument executed by the Bank and the Executive.
8. Venue and Governing Law. This agreement and the rights and obligations
hereunder shall be governed by and construed in accordance with the
laws of the State of Tennessee. Any action concerning this agreement
shall be brought in the federal or state courts located in the County
of Hamilton, Tennessee, and each party consents to the venue and
jurisdiction of such courts.
9. Notice. Notices given pursuant to this agreement shall be in writing
and shall be deemed given when received and if mailed, shall be mailed
by United States registered or certified mail, if to the Bank or the
Company, to:
Cornerstone Community Bank
5319 Highway 153
Hixson, TN 37343
or if to the Executive, at the address set forth below the Executive's
signature line of this agreement.
10. No Waiver. No waiver by either party at any time of any breach by the
other party of, or compliance with, any condition or provision of this
agreement to be performed by the other party shall be deemed a waiver
of similar or dissimilar provisions or conditions at the same time or
any prior or subsequent time.
11. Company Consent. This agreement is conditioned upon the consent of the
Company and the Company's agreement to implement those provisions of
the agreement over which it has control.
12. Headings. The headings herein contained are for reference only and
shall not affect the meaning or interpretation of any provision of
this agreement.
13. Entire Agreement. This agreement expresses the entire agreement of the
parties with respect to the subject matter hereof.
<PAGE> 4
IN WITNESS WHEREOF, the parties have executed this agreement as of the day and
year first written above.
CORNERSTONE COMMUNITY BANK
EXECUTIVE:
By: Jerry D. Lee
----------------------------------
Title: Executive Vice President and
Senior Loan Administrator
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Cornerstone Bancshares, Inc.
We hereby consent to the inclusion in this registration statement on Form S-1 of
our report, dated January 15, 1999, on our audits of the consolidated financial
statements of Cornerstone Bancshares, Inc. as of December 1998 and 1997, and for
the two-year period ended December 31, 1998. We also consent to the reference to
our firm under the caption "Experts."
/s/ Hazlett, Lewis & Bieter, PLLC
Chattanooga, Tennessee
January 27, 2000
