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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2009 File Number 000-51950
CORNERSTONE BANCORP
(Exact name of registrant as specified in its Charter)
South Carolina 57-1077978
(State or Other Jurisdiction (IRS Employer Identification Number)
of Incorporation or Organization)
1670 East Main Street, Easley, South Carolina 29640
(Address of Principal Executive Office, Zip Code)
Registrant's Telephone Number, Including Area Code: (864) 306-1444
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g)
of the Act: Common Stock, no par value
Indicate by check mark if the registrant is a well-known seasoned issuer as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T during the
preceding 12 months (or for such shorter period that the registrant was required
to submit and post such files). Yes [ ] No [ ] (Not yet applicable to
Registrant)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The aggregate market value of the voting Common Stock held by non-affiliates
computed by reference to the average of the high and low bid prices of the
Common Stock reported on the OTC Bulletin Board on June 30, 2009, the last day
of the registrant's most recently completed second fiscal quarter, was
approximately $6,985,892. The issuer has no non-voting common equity
outstanding. For purposes of the foregoing calculation only, all directors and
executive officers of the registrant have been deemed affiliates.
As of March 10, 2010, there were 2,105,738 shares of the registrant's Common
Stock, no par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the Registrant's 2009 Annual Report to Shareholders are
incorporated by reference into Part II of this Form 10-K.
(2) Portions of the Registrant's 2010 Proxy Statement are incorporated by
reference into Part III of this Form 10-K.
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10-K CROSS REFERENCE INDEX
Page
PART I
Item 1. Business................................................................................................3
Item 1A. Risk Factors...........................................................................................12
Item 1B. Unresolved Staff Comments..............................................................................16
Item 2. Properties.............................................................................................16
Item 3. Legal Proceedings......................................................................................16
Item 4. (Removed and Reserved).................................................................................16
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities......................................................................................16
Item 6. Selected Financial Data................................................................................16
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..................17
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.............................................17
Item 8. Financial Statements and Supplementary Data............................................................17
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure...................17
Item 9A(T). Controls and Procedures................................................................................17
Item 9B. Other Information......................................................................................18
PART III
Item 10. Directors, Executive Officers and Corporate Governance.................................................18
Item 11. Executive Compensation.................................................................................18
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.........18
Item 13. Certain Relationships and Related Transactions, and Director Independence..............................19
Item 14. Principal Accountant Fees and Services.................................................................19
Item 15. Exhibits, Financial Statement Schedules................................................................19
CAUTIONARY NOTICE WITH RESPECT TO FORWARD LOOKING STATEMENTS
Statements included in this report which are not historical in nature
are intended to be, and are hereby identified as "forward looking statements"
for purposes of the safe harbor provided by Section 21E of the Securities
Exchange Act of 1934, as amended. Words such as "estimate," "project," "intend,"
"expect," "believe," "anticipate," "plan," "may," "will," "should," "could,"
"would," "assume," "indicate," "contemplate," "seek," "target," "potential," and
similar expressions identify forward-looking statements. The Company cautions
readers that forward looking statements including without limitation, those
relating to the Company's new offices, future business prospects, revenues,
working capital, adequacy of the allowance for loan losses, liquidity, capital
needs, interest costs, and income, are subject to certain risks and
uncertainties that could cause actual results to differ from those indicated in
the forward looking statements, due to several important factors identified in
this report, among others, and other risks and factors identified from time to
time in the Company's other reports filed with the Securities and Exchange
Commission.
These forward-looking statements are based on our current expectations,
estimates and projections about our industry, management's beliefs, and
assumptions made by management. Such information includes, without limitation,
discussions as to estimates, expectations, beliefs, plans, strategies, and
objectives concerning the Company's future financial and operating performance.
These statements are not guarantees of future performance and are subject to
risks, uncertainties and assumptions that are difficult to predict, particularly
in light of the fact that the Company is a relatively new company with limited
operating history. Therefore, actual results may differ materially from those
expressed or forecasted in such forward-looking statements. The risks and
uncertainties include, but are not limited to:
o future economic and business conditions;
o the Company's growth and ability to maintain growth;
o governmental monetary and fiscal policies;
o legislative and regulatory changes;
o the effect of interest rate changes on our level, costs and
composition of deposits, loan demand, and the values of our loan
collateral, securities, and interest sensitive assets and
liabilities;
o the effects of competition from a wide variety of local,
regional, national and other providers of financial, investment
and insurance services, as well as competitors that offer banking
products and services by mail, telephone, computer, and/or the
Internet;
o credit risks;
o higher than anticipated levels of defaults on loans;
o perceptions by depositors about the safety of deposits;
o failure of our customers to repay loans;
o failure of assumptions underlying the establishment of the
allowance for loan losses, including the value of collateral
securing loans;
o the risks of opening new offices, including, without limitation,
the related costs and time of building customer relationships and
integrating operations, and the risk of failure to achieve
expected gains, revenue growth and/or expense savings;
o changes in accounting policies, rules, and practices;
o cost and difficulty of implementing changes in technology or
products;
o loss of consumer confidence and economic disruptions resulting
from terrorist activities;
o ability to weather the current economic downturn;
o loss of consumer or investor confidence; and
o other factors and information described in this report and in any
of the other reports we file with the Securities and Exchange
Commission under the Securities Act of 1934.
All forward-looking statements are expressly qualified in their
entirety by this cautionary notice. The Company undertakes no obligation to
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publicly update or revise any forward-looking statements, whether as a result of
new information, future events or otherwise. In light of these risks,
uncertainties, and assumptions, the forward-looking events discussed in this
report might not occur.
WEBSITE REFERENCES
References to our Bank's website included in, or incorporated by
reference into, this report are for information purposes only, and are not
intended to incorporate our website by reference into this report.
PART I
Item 1. Business.
General
Cornerstone Bancorp (the "Company") is a South Carolina corporation
incorporated in 1999. The Company is a bank holding company with no operations
other than those carried on by its wholly owned subsidiary, Cornerstone National
Bank (the "Bank"). The Bank was organized in 1999 and conducts a general banking
business under a national bank charter granted by the Office of the Comptroller
of the Currency of the United States (the "OCC") pursuant to the National Bank
Act. The Bank conducts its activities from its main office in the City of Easley
in Pickens County, South Carolina, which opened in September, 1999, and from a
branch office located in the Berea area of Greenville County, South Carolina,
which opened in August, 2002, and from a branch office in the
Powdersville/Piedmont area of Anderson County, South Carolina, which opened in
July 2005. In 2004, our bank established a wholly owned subsidiary, Crescent
Financial Services, Inc. ("Crescent"), which is an insurance agency that has not
yet engaged in any significant operations.
The Bank's primary market areas are the city of Easley, South Carolina
and the immediately surrounding areas of Pickens County, the Berea area of
Greenville County, and the Powdersville and Piedmont areas of Anderson County,
and contiguous areas. Pickens County is included in the Greenville, South
Carolina Metropolitan Statistical Area (the "Greenville MSA"). Anderson County
is part of the Anderson, South Carolina MSA.
The Bank's business primarily consists of accepting deposits and making
loans. The Bank seeks deposit accounts from households and businesses in its
primary market areas by offering a full range of savings accounts, retirement
accounts, checking accounts, money market accounts, and time certificates of
deposit. It also makes commercial, real estate and installment loans, primarily
on a secured basis, to borrowers in the Upstate area of South Carolina and makes
other authorized investments. The Bank offers both in-house and, when market
conditions reasonably allow, brokered conventional residential mortgage loans.
Brokered loans are funded by a third party investor. The Bank stopped making
brokered residential mortgage loans in November 2009 because of difficulties
created by current market conditions in brokering such loans to third party
investors. The Bank plans to reevaluate offering conventional 30- and 15-year
mortgage loans when the housing and mortgage lending markets stabilize. The Bank
does not hold any mortgage loans for sale.
As of December 31, 2009, the Bank employed 36 people.
Competition
South Carolina law permits statewide branching by banks and savings and
loan associations. Consequently, many financial institutions have branches
located in several communities. According to the FDIC Summary of Deposits at
June 30, 2009, in addition to the Bank, nine commercial banks and two savings
institutions operate branches in Pickens County. In addition to the Bank, 29
commercial banks and five savings institutions operate branches in Greenville
County. In addition to the Bank, 20 commercial banks and one savings institution
operate branches in Anderson County. The principal areas and methods of
competition in the banking industry are the services offered, pricing of those
services, the convenience and availability of the services, and the degree of
expertise and personal manner with which those services are offered.
The Bank encounters strong competition from most of the financial
institutions in its extended market area. In the conduct of certain areas of its
business, the Bank also competes with credit unions, insurance companies, money
market mutual funds and other financial institutions, some of which are not
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subject to the same degree of regulation and restrictions as the Bank. Most of
these competitors have substantially greater resources and lending abilities
than the Bank and offer certain services, such as international banking,
investment banking, and trust services, which the Bank does not presently
provide.
SERVICES OF THE BANK
Deposits
The Bank offers the full range of deposit services typically available
in most banks and savings and loan associations, including checking accounts,
NOW accounts, retirement accounts (including Individual Retirement Accounts),
and savings and other time deposits of various types, ranging from daily money
market accounts to longer-term certificates of deposit. The transaction accounts
and time certificates are tailored to the principal market area at rates
competitive with those offered in the area. All deposit accounts are insured by
the Federal Deposit Insurance Corporation ("FDIC") up to the maximum amount
permitted by law. The Bank solicits these accounts from individuals, businesses,
associations and organizations, and government authorities.
Lending Activities
The Bank offers a range of lending services, including, commercial
loans, consumer loans, and real estate mortgage loans. To address the risks
inherent in making loans, management maintains an allowance for loan losses
based on, among other things, an evaluation of the Bank's loan loss experience,
management's experience at other financial institutions in the market area, the
amount of and trends in past due and nonperforming loans, current and
anticipated economic changes and the values of loan collateral. Based upon such
factors, management makes various assumptions and judgments about the ultimate
collectibility of the loan portfolio and provides an allowance for potential
loan losses based upon a percentage of the outstanding balances and specific
loans. However, because there are certain risks that cannot be precisely
quantified, management's judgment of the allowance is necessarily approximate
and imprecise. The adequacy and methodology of the allowance for loan losses is
also subject to regulatory examination.
Real Estate Loans
One of the primary components of the Bank's loan portfolio is loans
secured by first or second mortgages on residential and commercial real estate.
These loans generally consist of short to mid-term commercial real estate loans,
construction and development loans and residential real estate loans (including
home equity and second mortgage loans). Interest rates may be fixed or
adjustable and the Bank frequently charges an origination fee. The Bank seeks to
manage credit risk in the commercial real estate portfolio by emphasizing loans
on owner-occupied office and retail buildings where the loan-to-value ratio at
origination, established by independent appraisals, does not exceed 80%. In
addition, the Bank generally requires personal guarantees of the principal
owners of the property. The loan-to-value ratio at origination for first and
second mortgage loans generally does not exceed 80%, and for construction loans,
generally does not exceed 75% of cost. The Bank employs a reappraisal policy to
routinely monitor real estate collateral values on real estate loans where the
repayment is dependent on sale of the collateral. In addition, in an effort to
control interest rate risk, long term residential mortgages are not originated
for the Bank's portfolio.
The principal economic risk associated with all loans, including real
estate loans, is the creditworthiness of the borrowers. The ability of a
borrower to repay a real estate loan depends upon a number of economic factors,
including employment levels and fluctuations in the value of real estate. In the
case of a real estate construction loan, there is generally no income from the
underlying property during the construction period, and the developer's personal
obligations under the loan are typically limited. In the case of a real estate
purchase loan that is not fully amortized, the borrower may be unable to repay
the loan at the end of the loan term and thus may be forced to refinance the
loan at a higher interest rate, or, in certain cases, the borrower may default
as a result of its inability to refinance the loan. Each of these factors
increases the risk of nonpayment by the borrower.
In 2007, the Company increased real estate construction loans
approximately 60%. This segment of the Bank's business is managed in specific
ways in order to minimize the risks normally associated with construction
lending. Management requires lending personnel to visit job sites, maintain
frequent contact with borrowers and arrange for third-party inspections of
completed work prior to issuing additional construction loan draws. As a result
of the real estate crisis in the Bank's markets throughout 2009, the Bank
tightened underwriting standards. The Bank's loan policy now contains specific
minimum net worth requirements for borrowers, minimum debt coverage ratios, and
for loans to construct single family residential properties, written contracts
with the end purchaser that contain significant consequences to the purchaser
for terminating the contract.
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The Bank faces additional credit risks to the extent that it engages in
making adjustable rate mortgage loans ("ARMs"). In the case of an ARM, as
interest rates increase, the borrower's required payments increase, thus
increasing the potential for default. The marketability of all real estate
loans, including ARMs, is also generally affected by the prevailing level of
interest rates.
Commercial Loans
The Bank makes loans for commercial purposes in various lines of
business. Commercial loans include both secured and unsecured loans for working
capital (including inventory and receivables), loans for business expansion
(including acquisition of real estate and improvements), and loans for purchases
of equipment and machinery. Equipment loans are typically made for a term of
five years or less at either fixed or variable rates, with the loan fully
amortized over the term and secured by the financed equipment. Working capital
loans typically have terms not exceeding one year and are usually secured by
accounts receivable, inventory or personal guarantees of the principals of the
business. Commercial loans vary greatly depending upon the circumstances and
loan terms are structured on a case-by-case basis to better serve customer
needs.
The risks associated with commercial loans vary with many economic
factors, including the economy in the Bank's market areas. The well-established
banks in the Bank's market areas make proportionately more loans to medium- to
large-sized businesses than the Bank makes. Many of the Bank's commercial loans
are made to small- to medium-sized businesses, which are not only smaller, but
may have shorter operating histories and less sophisticated record keeping
systems than larger entities. As a result, these smaller entities may be less
able to withstand adverse competitive, economic and financial conditions than
larger borrowers. In addition, because payments on loans secured by commercial
property generally depend to a large degree on the results of operations and
management of the properties, repayment of such loans may be subject, to a
greater extent than other loans, to adverse conditions in the real estate market
or the economy.
Consumer Loans
The Bank makes a variety of loans to individuals for personal and
household purposes, including secured and unsecured installment and term loans,
home equity loans and lines of credit and unsecured revolving lines of credit.
The secured installment and term loans to consumers generally consist of loans
to purchase automobiles, boats, recreational vehicles, mobile homes and
household furnishings, with the collateral for each loan being the purchased
property. The underwriting criteria for home equity loans and lines of credit
are generally the same as applied by the Bank when making a first mortgage loan,
as described above, and home equity lines of credit typically expire 15 years or
less after origination, unless renewed or extended.
Consumer loans generally involve more credit risks than other loans
because of the type and nature of the underlying collateral or because of the
absence of any collateral. Consumer loan repayments are dependent on the
borrower's continuing financial stability and are likely to be adversely
affected by job loss, divorce and illness. Furthermore, the application of
various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans in
the case of default. In most cases, any repossessed collateral will not provide
an adequate source of repayment of the outstanding loan balance. Although the
underwriting process for consumer loans includes a comparison of the value of
the security, if any, to the proposed loan amount, the Bank cannot predict the
extent to which the borrower's ability to pay, and the value of the security,
will be affected by prevailing economic and other conditions.
Other Services
The Bank participates in a regional network of automated teller
machines that may be used by Bank customers in major cities throughout the
Southeast. The Bank offers both VISA and MasterCard brands of credit and debit
cards together with related lines of credit. The lines of credit may be used for
overdraft protection as well as pre-authorized credit for personal purchases and
expenses. Credit cards are underwritten and funded by a third party provider.
The Bank also provides stored value cards, direct deposit of payroll and social
security checks, and automatic drafts for various accounts, but does not
currently provide international or trust banking services, other than foreign
currency exchange through a correspondent bank. The Bank offers an Internet
banking product accessible via the Bank's custom website at
www.cornerstonenatlbank.com. The interactive banking product includes an
electronic bill payment service that allows customers to make scheduled and/or
recurring bill payments electronically. The Bank also offers remote check
deposit services to commercial and small business customers. The Bank also
offers merchant and other business related services to its commercial customers.
5
Until November 2009, the Bank had a residential mortgage loan
department with a highly experienced staff qualified to make many types of
residential mortgage loans. In an effort to control interest rate risk, long
term residential mortgages were underwritten and funded by, and closed in the
name of, third party lenders. Since the third quarter of 2007, some of the third
party lenders that offer long term residential mortgages to the Bank's customers
no longer offered certain lending programs, or tightened credit standards in
response to the crisis in the sub-prime segment of the mortgage lending market.
As a result, there was a significant decrease in the volume of residential
mortgages processed by the Bank's mortgage lending staff. In November 30, 2009
the Bank determined that the volume of mortgage loans had decreased so much that
it would be prudent to discontinue offering longer term mortgage loans. When the
market for long term mortgages appears to have stabilized, management plans to
reevaluate the possibility of offering long term residential mortgages.
Asset and Liability Management
The Bank's primary earning assets consist of the loan portfolio and
investment portfolio. Management generally makes efforts to match maturities and
rates of loans and the investment portfolio with those of deposits, although
exact matching is not possible. The majority of the Bank's securities
investments are in marketable obligations of government sponsored enterprises
and state and municipal governments, generally with varied maturities.
Long-term loans are priced primarily to be interest-rate sensitive with
only a small portion of the Bank's portfolio of long-term loans at fixed rates.
Such fixed-rate loans generally do not have maturities longer than fifteen
years, except in exceptional cases.
Deposit accounts represent the majority of the Bank's liabilities.
These include transaction accounts, savings and money market accounts and
certificates of deposit. The maturities or repricing horizons of the majority of
interest-sensitive accounts are 12 months or less.
Additional Information
For additional information about the business of the Company and the
Bank, see Item 7- "Management's Discussion and Analysis or Plan of Operation."
Offices
The Company's and Bank's main office is located at 1670 East Main
Street in Easley, South Carolina. The Bank also maintains full-service branch
locations at 45 Farrs Bridge Road in the Berea area of Greenville, South
Carolina and at 11000 Anderson Highway in the Powdersville area of Piedmont,
South Carolina. An operations center is located at 1664 East Main Street in
Easley, South Carolina. The Company owns all of these properties and believes
they are well-suited to the banking business.
SUPERVISION AND REGULATION
Bank holding companies and banks are extensively regulated under
federal and state law. To the extent that the following information describes
statutory and regulatory provisions, it is qualified in its entirety by
reference to such statutes and regulations. Any change in applicable law or
regulation may have a material effect on the business of the Company and the
Bank.
General
The Company and the Bank operate in a highly regulated environment, and
their business activities are governed by statute, regulation, and
administrative policies, and supervised by a number of federal regulatory
agencies, including the Board of Governors of the Federal Reserve System (the
"Federal Reserve"), the Comptroller of the Currency (the "OCC"), and the FDIC.
The Company is also subject to limited regulation by the South Carolina State
Board of Financial Institutions. The following discussion summarizes some of the
relevant aspects of the laws and regulations that affect the Company and the
Bank. It is important to note that these laws and regulations are intended
primarily for the benefit and protection of the Bank's depositors and the
Depository Insurance Fund, and not for the protection of the Company's
shareholders or creditors. Proposals to change the laws and regulations that
govern the banking industry are frequently raised in Congress, state
legislatures, and various bank regulatory agencies, and such proposals have
significantly increased in the wake of the recent financial crisis. Furthermore,
financial institutions are being subjected to increased scrutiny and enforcement
activity by state and federal banking agencies, the United States Department of
6
Justice, the Securities and Exchange Commission, and other state and federal
regulatory agencies. This increased scrutiny and enforcement activity entails
significant potential increases in compliance requirements and associated costs.
Regulation of the Company by the Federal Reserve
The Company is regulated by the Federal Reserve under the BHCA. Under
the BHCA, the Company's activities and those of its subsidiaries are limited to
banking, managing or controlling banks, furnishing services to or performing
services for its subsidiaries or engaging in any other activity which the
Federal Reserve determines to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto. The Company may engage in
a broader range of activities if it becomes a "financial holding company"
pursuant to the Gramm-Leach-Bliley Act, which is described below under the
caption "Gramm-Leach-Bliley Act"." The BHCA prohibits the Company from acquiring
direct or indirect control of more than 5% of the outstanding voting stock or
substantially all of the assets of any bank or from merging or consolidating
with another bank holding company without prior approval of the Federal Reserve.
Additionally, the BHCA prohibits the Company from engaging in or from acquiring
ownership or control of more than 5% of the outstanding voting stock of any
company engaged in a non-banking business unless such business is determined by
the Federal Reserve to be so closely related to banking as to be properly
incident thereto. The BHCA generally does not place territorial restrictions on
the activities of such non-banking related activities.
Obligations of the Company to its Subsidiary Bank
A number of obligations and restrictions are imposed on bank holding
companies and their depository institution subsidiaries by Federal law and
regulatory policy that are designed to reduce potential loss exposure to the
depositors of such depository institutions and to the FDIC insurance fund in the
event the depository institution is in danger of becoming insolvent or is
insolvent. For example, under the policy of the Federal Reserve, a bank holding
company is required to serve as a source of financial strength to its subsidiary
depository institutions and to commit resources to support such institutions in
circumstances where it might not do so absent such policy. In addition, the
"cross-guarantee" provisions of the Federal Deposit Insurance Act, as amended
("FDIA"), require insured depository institutions under common control to
reimburse the FDIC for any loss suffered or reasonably anticipated by the
Deposit Insurance Fund of the FDIC as a result of the default of a commonly
controlled insured depository institution or for any assistance provided by the
FDIC to a commonly controlled insured depository institution in danger of
default. The FDIC may decline to enforce the cross-guarantee provisions if it
determines that a waiver is in the best interest of the Deposit Insurance Fund.
The FDIC's claim for damages is superior to claims of shareholders of the
insured depository institution or its holding company but is subordinate to
claims of depositors, secured creditors and holders of subordinated debt (other
than affiliates) of the commonly controlled insured depository institutions.
The FDIA also provides that amounts received from the liquidation or
other resolution of any insured depository institution by any receiver must be
distributed (after payment of secured claims) to pay the deposit liabilities of
the institution prior to payment of any other general or unsecured senior
liability, subordinated liability, general creditor or shareholder. This
provision gives depositors a preference over general and subordinated creditors
and shareholders in the event a receiver is appointed to distribute the assets
of the Bank.
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.
Under the National Bank Act, if the capital stock of a national bank is
impaired by losses or otherwise, the OCC is authorized to require payment of the
deficiency by assessment upon the bank's shareholders, pro rata, and to the
extent necessary, if any such assessment is not paid by any shareholder after
three months notice, to sell the stock of such shareholder to make good the
deficiency.
7
Capital Adequacy Guidelines for Bank Holding Companies and National Banks
The various federal bank regulators, including the Federal Reserve and
the OCC have adopted risk-based and leverage capital adequacy guidelines for
assessing bank holding company and bank capital adequacy. These standards define
what qualifies as capital and establish minimum capital standards in relation to
assets and off-balance sheet exposures, as adjusted for credit risks. In
addition, the OCC may establish individual minimum capital requirements for a
national bank that are different from the general requirements.
Failure to meet capital requirements could subject the Bank to a
variety of enforcement remedies, ranging from, for example, prohibition of the
taking of brokered deposits to the termination of deposit insurance by the FDIC
or the appointment of a receiver.
The risk-based capital standards of both the Federal Reserve and the
OCC explicitly identify concentrations of credit risk and the risk arising from
non-traditional activities, as well as an institution's ability to manage these
risks, as important factors to be taken into account by the agencies in
assessing an institution's overall capital adequacy. The capital guidelines also
provide that an institution's exposure to a decline in the economic value of its
capital due to changes in interest rates should be considered by the agencies as
a factor in evaluating a bank's capital adequacy. The Federal Reserve also has
issued additional capital guidelines for bank holding companies that engage in
certain trading activities.
The Bank exceeded all applicable capital requirements at December 31,
2009. The Company is also subject to capital requirements established by the
Federal Reserve, which establish minimum ratios for capital adequacy as they
apply to the Bank. For 2009, the Company also met its capital ratios. Additional
information about regulatory capital requirements is set forth in Note 20 to the
Company's Financial Statements, which are included in the 2009 Annual Report to
Shareholders filed as Exhibit 13 to this Form 10-K (the "2009 Annual Report").
Payment of Dividends
The Company is a legal entity separate and distinct from its bank
subsidiary. Most of the revenues of the Company are expected to result from
dividends paid to the Company by the Bank. There are statutory and regulatory
requirements applicable to the payment of dividends by the Bank to the Company
as well as by the Company to its shareholders.
Certain Transactions by the Company with its Affiliates
Federal law regulates transactions among the Company and its
affiliates, including the amount of bank loans to or investments in nonbank
affiliates and the amount of advances to third parties collateralized by
securities of an affiliate. Further, a bank holding company and its affiliates
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.
FDIC Insurance Assessments
The FDIC merged the Bank Insurance Fund and the Savings Association
Insurance Fund to form the Deposit Insurance Fund ("DIF") on March 31, 2006 in
accordance with the Federal Deposit Insurance Reform Act of 2005. The FDIC
maintains the DIF by assessing depository institutions an insurance premium. The
amount each institution is assessed is based upon statutory factors that include
the balance of insured deposits as well as the degree of risk the institution
poses to the insurance fund. The FDIC uses a risk-based premium system that
assesses higher rates on those institutions that pose greater risks to the DIF.
Since January 1, 2007, the FDIC has placed each institution in one of four risk
categories using a two-step process based first on capital ratios (the capital
group assignment) and then on other relevant information (the supervisory group
assignment). As a result of recent bank failures and in order to increase the
amount in the DIF to reflect the increased risk of additional bank failures and
insurance claims, the FDIC raised its assessments on banks for 2009, and
collected a special assessment. The Bank's portion of the special assessment
totaled $80,894, and was paid in September, 2009 based on deposits at June 30,
2009. The FDIC also required insured institutions to pay three years of deposit
insurance premiums in advance. On December 30, 2009 the FDIC collected $997,152
from the Company for deposit insurance premiums. Of that amount, $63,002 related
to the regular quarterly assessment, and $934,150 related to the prepayment of
premiums for the years 2010, 2011 and 2012. In 2010 and the following two years,
on a quarterly basis, the FDIC will continue to calculate the assessment amount
with then current financial information, and will deduct the quarterly
assessment amount from the prepaid balance. The Bank will expense the current
portion as calculated by the FDIC.
8
Regulation of the Bank
The Bank is subject to the National Bank Act and the regulations of the
OCC as well as to examination by the OCC. The Bank is also subject to various
other state and federal laws and regulations, including state usury laws, laws
relating to fiduciaries, consumer credit laws and laws relating to branch
banking. The Bank's loan operations are subject to certain federal consumer
credit laws and regulations promulgated thereunder, including, but not limited
to: the federal Truth-In-Lending Act, governing disclosures of credit terms to
consumer borrowers; the Home Mortgage Disclosure Act, requiring financial
institutions to provide certain information concerning their mortgage lending;
the Equal Credit Opportunity Act and the Fair Housing Act, prohibiting
discrimination on the basis of certain prohibited factors in extending credit;
the Fair Credit Reporting Act, governing the use and provision of information to
credit reporting agencies; the Bank Secrecy Act, dealing with, among other
things, the reporting of certain currency transactions; and the Fair Debt
Collection Act, governing the manner in which consumer debts may be collected by
collection agencies. The deposit operations of the Bank are subject to the Truth
in Savings Act, requiring certain disclosures about rates paid on savings
accounts; the Expedited Funds Availability Act, which deals with disclosure of
the availability of funds deposited in accounts and the collection and return of
checks by banks; the Right to Financial Privacy Act, which imposes a duty to
maintain certain confidentiality of consumer financial records, and the
Electronic Funds Transfer Act and regulations promulgated thereunder, which
govern automatic deposits to and withdrawals from deposit accounts and
customers' rights and liabilities arising from the use of automated teller
machines and other electronic banking services.
The Bank is also subject to the requirements of the Community
Reinvestment Act (the "CRA"). The CRA imposes on financial institutions an
affirmative and ongoing obligation to meet the credit needs of their local
communities, including low- and moderate-income neighborhoods, consistent with
the safe and sound operation of those institutions. Each financial institution's
actual performance in meeting community credit needs is evaluated as part of the
examination process, and also is considered in evaluating mergers, acquisitions
and applications to open a branch or facility.
Other Safety and Soundness Regulations
Prompt Corrective Action. The federal banking agencies have broad
powers under current federal law to take prompt corrective action to resolve
problems of insured depository institutions. The extent of these powers depends
upon whether the institutions in question are "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" or
"critically undercapitalized."
A bank that is "undercapitalized" becomes subject to provisions of the
FDIA: restricting payment of capital distributions and management fees;
requiring the FDIC to monitor the condition of the bank; requiring submission by
the bank of a capital restoration plan; restricting the growth of the bank's
assets and requiring prior approval of certain expansion proposals. A bank that
is "significantly undercapitalized" is also subject to restrictions on
compensation paid to senior management of the bank, and a bank that is
"critically undercapitalized" is further subject to restrictions on the
activities of the bank and restrictions on payments of subordinated debt of the
bank. The purpose of these provisions is to require banks with less than
adequate capital to act quickly to restore their capital and to have the FDIC
move promptly to take over banks that are unwilling or unable to take such
steps.
Brokered Deposits. Under current FDIC regulations, "well capitalized"
banks may accept brokered deposits without restriction, "adequately capitalized"
banks may accept brokered deposits with a waiver from the FDIC (subject to
certain restrictions on payment of rates), while "undercapitalized" banks may
not accept brokered deposits.
Interstate Banking
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act
of 1994 the Company and any other adequately capitalized bank holding company
located in South Carolina can acquire a bank located in any other state, and a
bank holding company located outside South Carolina can acquire any South
Carolina-based bank, in either case subject to certain deposit percentage and
other restrictions. Unless prohibited by state law, adequately capitalized and
managed bank holding companies are permitted to consolidate their multistate
bank operations into a single bank subsidiary and to branch interstate through
acquisitions. De novo branching by an out-of-state bank is permitted only if the
laws of the host state expressly permit it. The authority of a bank to establish
and operate branches within a state continue to be subject to applicable state
branching laws. South Carolina law permits such interstate branching but not de
novo branching by an out-of-state bank.
9
Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act, which makes it easier for affiliations
between banks, securities firms and insurance companies to take place, removes
Depression-era barriers that had separated banks and securities firms, and seeks
to protect the privacy of consumers' financial information.
Under provisions of the act and regulations adopted by the applicable
regulators, banks, securities firms and insurance companies are able to
structure new affiliations through a holding company structure or through a
financial subsidiary. The legislation creates a type of bank holding company
called a "financial holding company" which has powers much more extensive than
those of standard holding companies. These expanded powers include authority to
engage in "financial activities," which are activities that are (1) financial in
nature; (2) incidental to activities that are financial in nature; or (3)
complementary to a financial activity and that do not impose a safety and
soundness risk. Significantly, the permitted financial activities for financial
holding companies include authority to engage in merchant banking and insurance
activities, including insurance portfolio investing. A bank holding company can
qualify as a financial holding company and expand the services it offers only if
all of its subsidiary depository institutions are well managed, well capitalized
and have received a rating of "satisfactory" on their last Community
Reinvestment Act examination.
The legislation also creates another type of entity called a "financial
subsidiary." A financial subsidiary may be used by a national bank or a group of
national banks to engage in many of the same activities permitted for a
financial holding company, though several of these activities, including real
estate development or investment, insurance or annuity underwriting, insurance
portfolio investing and merchant banking, are reserved for financial holding
companies. A bank's investment in a financial subsidiary affects the way in
which the bank calculates its regulatory capital, and the assets and liabilities
of financial subsidiaries may not be consolidated with those of the bank. The
bank must also be certain that its risk management procedures are adequate to
protect it from financial and operational risks created both by itself and by
any financial subsidiary. Further, the bank must establish policies to maintain
the separate corporate identities of the bank and its financial subsidiary and
to prevent each from becoming liable for the obligations of the other.
The Act also establishes the concept of "functional supervision,"
meaning that similar activities should be regulated by the same regulator.
Accordingly, the Act spells out the regulatory authority of the bank regulatory
agencies, the Securities and Exchange Commission and state insurance regulators
so that each type of activity is supervised by a regulator with corresponding
expertise. The Federal Reserve Board is intended to be an umbrella supervisor
with the authority to require a bank holding company or financial holding
company or any subsidiary of either to file reports as to its financial
condition, risk management systems, transactions with depository institution
subsidiaries and affiliates, and compliance with any federal law that it has
authority to enforce.
Although the Act reaffirms that states are the regulators for insurance
activities of all persons, including federally chartered banks, the Act
prohibits states from preventing depository institutions and their affiliates
from conducting insurance activities.
The Act also establishes a minimum federal standard of privacy to
protect the confidentiality of a consumer's personal financial information and
gives the consumer the power to choose how personal financial information may be
used by financial institutions. The privacy provisions of the Act have been
implemented by adoption of regulations by various Federal agencies. The
regulations govern the customer's right to opt out of further disclosure of
nonpublic personal financial information, and require the Bank to provide
initial and annual privacy notices. The Bank is also required to develop a
comprehensive plan for the safeguarding of customer information that encompasses
all aspects of the Bank's technological environment, business practices, and
Bank facilities.
The Act and the regulations adopted pursuant to the Act create new
opportunities for the Company to offer expanded services to customers in the
future, though the Company has not yet determined what the nature of the
expanded services might be or when the Company might find it feasible to offer
them. The Act has increased competition from larger financial institutions that
are currently more capable than the Company of taking advantage of the
opportunity to provide a broader range of services. However, the Company
continues to believe that its commitment to providing high quality, personalized
service to customers will permit it to remain competitive in its market area.
10
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act was signed into law on July 30, 2002, and
mandated extensive reforms and requirements for public companies. The SEC has
adopted extensive regulations pursuant to the requirements of the Sarbanes-Oxley
Act. The Sarbanes-Oxley Act and the SEC's regulations have increased the
Company's cost of doing business, particularly its fees for internal and
external audit services and legal services, and the law and regulations are
expected to continue to do so. However, the Company does not believe that it
will be affected by Sarbanes-Oxley and the SEC regulations in ways that are
materially different or more onerous than those of other public companies of
similar size and in similar businesses.
Legislative Proposals
Proposed legislation, which could significantly affect the business of
banking, is introduced in Congress and the South Carolina Legislature from time
to time. For example, numerous bills are pending in Congress and the South
Carolina Legislature to provide various forms of relief to homeowners from
foreclosure of mortgages as a result of publicity surrounding economic problems
resulting from subprime mortgage lending and the economic adjustments in
national real estate markets. Broader problems in the financial sector of the
economy, which became apparent in 2008, have led to numerous calls for, and
legislative and regulatory proposals relating to, restructuring of the
regulation of financial institutions. Management of the Company cannot predict
the future course of such legislative proposals or their impact on the Company
and the Bank should they be adopted.
Fiscal and Monetary Policy
Banking is a business that depends largely on interest rate
differentials. In general, the difference between the interest paid by a bank on
its deposits and its other borrowings, and the interest received by a bank on
its loans and securities holdings, constitutes the major portion of a bank's
earnings. Thus, the earnings and growth of the Company and the Bank are subject
to the influence of economic conditions generally, both domestic and foreign,
and also to the monetary and fiscal policies of the United States and its
agencies, particularly the Federal Reserve. The Federal Reserve regulates the
supply of money through various means, including open-market dealings in United
States government securities, the discount rate at which banks may borrow from
the Federal Reserve, and the reserve requirements on deposits. The nature and
timing of any changes in such policies and their impact on the Company and the
Bank cannot be predicted.
Governmental Response to Recent Financial Crisis
During the fourth quarter of 2008 and continuing throughout 2009 the
FDIC, the Federal Reserve, the Department of the Treasury and Congress took a
number of actions designed to alleviate or correct mounting problems in the
financial services industry. A number of these initiatives were directly
applicable to community banks.
Congress enacted the Emergency Economic Stabilization Act of 2008
which, among other things, temporarily increased the maximum amount of FDIC
deposit insurance from $100,000 to $250,000 and created a Troubled Assets Relief
Program ("TARP") administered by Treasury. In October, 2008, Treasury announced
a Capital Purchase Program ("CPP") under TARP to increase the capital of healthy
banks. Under the CPP, Treasury would purchase preferred stock with warrants from
qualified banks and bank holding companies in an amount up to 3% of the seller's
risk-weighed assets as of September 30, 2008. Institutions wishing to
participate in the CPP were required to file an application with their principal
federal regulators. The Company filed such an application and received
preliminary approval to sell preferred stock to the Treasury, but ultimately
elected not to participate in the CPP because of (i) the cost of the preferred
stock, (ii) the open-ended administrative burdens associated with the preferred
stock, including having to agree to allow Treasury to amend unilaterally the
stock purchase agreement to comply with subsequent changes in applicable federal
statutes, (iii) the fact that the Company and the Bank were already well
capitalized under regulatory guidelines and expected to continue to be so, and
(iv) management's belief that other sources of capital were, and would continue
to be, available should additional capital be needed.
The FDIC also implemented in October, 2008 a Temporary Liquidity
Guarantee Program consisting of a deposit insurance component pursuant to which
it undertook to provide deposit insurance in an unlimited amount for
non-interest bearing transaction accounts, and a debt guarantee component
pursuant to which it undertook to fully guarantee senior, unsecured debt issued
by banks or bank holding companies. Coverage of both components was automatic
until December 5, 2008, at which time covered institutions could opt out of one
or both of the components. Institutions not opting out would be charged fees for
their participation in the components. The Bank did not opt out of either
component.
11
An unfortunate consequence of the difficulties that have beset the
banking industry in the last year has been a large increase in bank failures,
which has led to substantial claims being made against the FDIC's Deposit
Insurance Fund. See "FDIC Insurance Assessments" above for additional
information.
Additional governmental efforts to ameliorate the problems afflicting
the banking industry have been adopted or proposed, or are being considered by
Congress and various governmental entities. The Company is presently unable to
predict the impact of any such changes, although it appears that they are likely
to increase operating expenses in the near term without creating completely
offsetting benefits.
Item 1A. Risk Factors
Risks Related to Our Business
There can be no assurance that recent government actions will continue to
stabilize the U.S. financial system.
In response to the financial crises affecting the banking system and
financial markets and going concern threats to investment banks and other
financial institutions, various branches and agencies of the U.S. government
have put in place laws, regulations and programs to address capital and
liquidity issues in the banking system. There can be no assurance, however, as
to the actual impact that such laws, regulations and programs will have on the
financial markets, including the extreme levels of volatility, liquidity and
confidence issues, and limited credit availability currently being experienced.
The failure of such laws, regulations and programs to help stabilize the
financial markets and a continuation or worsening of current financial market
conditions could materially and adversely affect our business, financial
condition, results of operations, access to credit or the trading price of our
common stock.
Recent levels of market volatility are unprecedented.
The volatility and disruption of financial and credit markets has
reached unprecedented levels for recent times. In some cases, the markets have
produced downward pressure on stock prices and credit availability for certain
issuers without regard to those issuers' underlying financial strength. If
current levels of market disruption and volatility continue or worsen, there can
be no assurance that we will not experience an adverse effect, which may be
material, on our ability to access capital and on our business, financial
condition and results of operations.
The soundness of other financial institutions could adversely affect us.
Financial services institutions are interrelated as a result of
trading, clearing, counterparty, or other relationships. We have exposure to
many different industries and counterparties, and we routinely execute
transactions with counterparties in the financial services industry, including
brokers, dealers, commercial banks, investment banks, and government sponsored
enterprises. Many of these transactions expose us to credit risk in the event of
default of our counterparty. In addition, our credit risk may be exacerbated
when the collateral we hold cannot be realized or is liquidated at prices not
sufficient to recover the full amount of the loan or other obligation due us.
There is no assurance that any such losses would not materially and adversely
affect our results of operations or earnings.
Our primary source of funding for our operations is deposits from
customers in our local market. Should other banks in or near our market areas
fail, it could cause our deposit customers to lose confidence in banks and cause
them to withdraw or substantially restrict their deposits with us. If such
activity reached a high enough level, it could substantially disrupt our
business. There is no assurance that such disruptions, were they to occur, would
not materially and adversely affect our results of operations or earnings.
Current market developments may adversely affect our industry, business and
results of operations.
Dramatic declines in the housing market during the prior two years,
with falling home prices and increasing foreclosures and unemployment, have
resulted in significant write-downs of asset values by financial institutions,
including government-sponsored entities and major commercial and investment
banks. These write-downs, initially of mortgage-backed securities but spreading
12
to credit default swaps, other derivative securities, and mortgage loans have
caused many financial institutions to seek additional capital, to merge with
larger and stronger institutions and, in some cases, to fail. Reflecting concern
about the stability of the financial markets generally and the strength of
counterparties, many lenders and institutional investors have reduced, and in
some cases, ceased to provide funding to borrowers, including other financial
institutions. The resulting lack of available credit, lack of confidence in the
financial sector, increased volatility in the financial markets and reduced
business activity could materially and adversely, directly or indirectly, affect
our business, financial condition and results of operations.
Our long-term growth strategy will require future increases in capital that we
may not be able to accomplish.
We are required by banking regulators to maintain various ratios of
capital to assets. As our assets grow we expect our capital ratios to decline
unless we can increase our earnings or raise sufficient new capital to keep pace
with asset growth. Our ability to raise additional capital, if needed, will
depend, among other things, on conditions in the capital markets at that time,
which are outside our control, and on our financial condition and performance.
If we are unable to limit a capital ratio decline by increasing our capital, we
will have to restrict our asset growth as we approach the minimum required
capital to asset ratios.
We may be unable to successfully manage our future growth.
Our future profitability will depend in part on our ability to manage
growth successfully. Our ability to manage growth successfully will depend on
our ability to maintain cost controls and asset quality while attracting
additional loans and deposits, as well as on factors beyond our control, such as
economic conditions and interest rate trends. If we grow too quickly and are not
able to control costs and maintain asset quality, growth could materially
adversely affect our financial performance.
We depend on the services of a number of key personnel, and a loss of any of
those personnel could disrupt our operations and result in reduced revenues.
We are a relationship-driven organization. Our growth and development
to date have depended in large part on the efforts of our senior management
team. These senior officers have primary contact with our customers and are
extremely important in maintaining personalized relationships with our customer
base, which are key aspects of our business strategy, and in increasing our
market presence. The unexpected loss of services of one or more of these key
employees could have a material adverse effect on our operations and possibly
result in reduced revenues if we were unable to find suitable replacements
promptly.
If our loan customers do not pay us as they have contracted to, we may
experience losses.
Our principal revenue producing business is making loans. If our
customers do not repay the loans, we will suffer losses. Even though we maintain
an allowance for loan losses, the amount of the allowance may not be adequate to
cover the losses we experience. We attempt to mitigate this risk by a thorough
review of the creditworthiness of loan customers. Nevertheless, there is risk
that our credit evaluations will prove to be inaccurate due to changed
circumstances or otherwise.
Our business is concentrated in the Upstate area of South Carolina, and, as has
been the case over the past two years, a downturn in the economy of the area, a
decline in area real estate values or other events in our market area may
adversely affect our business.
Substantially all of our business is located in the Upstate area of
South Carolina. As a result, our financial condition and results of operations
are affected by changes in the Upstate economy. As has been the case over the
prior two years, a prolonged period of economic recession, a general decline in
real estate values in our market area or other adverse economic conditions in
the Upstate and South Carolina may result in decreases in demand for our
services, increases in nonpayment of loans and decreases in the value of
collateral securing loans, which could have a material adverse effect on our
business, future prospects, financial condition or results of operations. The
longer such adverse economic conditions persist, the greater the adverse impact
on us will be.
13
We face strong competition from larger, more established competitors which may
adversely affect our ability to operate profitably.
We encounter strong competition from financial institutions operating
in the Upstate area of South Carolina. In the conduct of our business, we also
compete with credit unions, insurance companies, money market mutual funds and
other financial institutions, some of which are not subject to the same degree
of regulation as we are. Many of these competitors have substantially greater
resources and lending abilities than we have and offer services, such as
investment banking, trust and international banking services that we do not
provide. We believe that we have been able to, and will continue to be able to,
compete effectively with these institutions because of our experienced bankers
and personalized service, as well as through loan participations and other
strategies and techniques. However, we cannot promise that we are correct in our
belief. If we are wrong, our ability to operate profitably may be negatively
affected.
Technological changes affect our business, and we may have fewer resources than
many of our competitors to invest in technological improvements.
The financial services industry continues to undergo rapid
technological changes with frequent introductions of new technology-driven
products and services. In addition to enabling financial institutions to serve
clients better, the effective use of technology may increase efficiency and may
enable financial institutions to reduce costs. Our future success may depend, in
part, upon our ability to use technology to provide products and services that
provide convenience to customers and to create additional efficiencies in our
operations. We may need to make significant additional capital investments in
technology in the future, and we may not be able to effectively implement new
technology-driven products and services. Many of our competitors have
substantially greater resources to invest in technological improvements.
Our profitability and liquidity are affected by changes in interest rates and
economic conditions.
Our profitability depends upon our net interest income, which is the
difference between interest earned on our interest earning assets, such as loans
and investment securities, and interest expense on interest bearing liabilities,
such as deposits and borrowings. Our net interest income is adversely affected
when market interest rates change such that the interest we pay on deposits and
borrowings increases faster than the interest earned on loans and investments,
or, conversely, when the interest earned on loans and investments decreases
faster than the interest we pay on deposits and borrowings. Interest rates, and
consequently our results of operations, are affected by general economic
conditions (domestic and foreign) and fiscal and monetary policies. Monetary and
fiscal policies may materially affect the level and direction of interest rates.
Increases in interest rates generally decrease the market values of interest
earning investments and loans held and therefore may adversely affect our
liquidity and earnings. Increased interest rates also generally affect the
volume of mortgage loan originations, the resale value of mortgage loans
originated for resale, and the ability of borrowers to perform under existing
loans of all types. In 2007 and 2008, the Federal Reserve decreased interest
rates significantly, and has held rates to historically low levels throughout
2009. When the Federal Reserve begins to increase interest rates back to
equilibrium rates, rapid increases in rates could expose the Bank to interest
rate risk. Management plans for possible changes in interest rates and takes
steps to capitalize on changes in rates to increase net interest income.
However, the difficulty in predicting the timing and magnitude of changes in
interest rates creates the risk that our plans are not properly suited to the
actual changes in rates that occur.
RISKS RELATED TO OUR COMMON STOCK
Our common stock has a limited trading market, which may make the prompt
execution of sale transactions difficult.
Although our common stock may be traded from time to time on an
individual basis, no active trading market has developed and none is likely to
develop in the foreseeable future. Our common stock is not traded on any
exchange. Accordingly, if you wish to sell shares you may experience a delay or
have to sell them at a lower price in order to sell them promptly, if at all.
We may issue additional securities, which could affect the market price of our
common stock and dilute your ownership.
We may issue additional securities to raise additional capital, to
support growth, or to make acquisitions. Sales of a substantial number of shares
of our common stock, or the perception by the market that those sales could
14
occur, could cause the market price of our common stock to decline or could make
it more difficult for us to raise capital through the sale of common stock or to
use our common stock in future acquisitions.
We do not plan to pay cash dividends in the foreseeable future.
We have paid a cash dividend only once, and do not plan to pay cash
dividends again in the foreseeable future. We plan to use the funds that might
otherwise be available to pay dividends to increase our capital and expand our
business.
Declaration and payment of dividends are within the discretion of our
board of directors. Our Bank will be our most likely source of funds with which
to pay cash dividends. Our Bank's declaration and payment of future dividends to
us are within the discretion of the Bank's board of directors, and are dependent
upon its earnings, financial condition, its need to retain earnings for use in
the business and any other pertinent factors. The Bank's payment of dividends is
also subject to various regulatory requirements.
Provisions in our articles of incorporation and South Carolina law may
discourage or prevent takeover attempts, and these provisions may have the
effect of reducing the market price for our stock.
Our articles of incorporation include several provisions that may have
the effect of discouraging or preventing hostile takeover attempts, and
therefore of making the removal of incumbent management difficult. In addition,
South Carolina law contains several provisions that may make it more difficult
for a third party to acquire control of us without the approval of our board of
directors, and may make it more difficult or expensive for a third party to
acquire a majority of our outstanding common stock. To the extent that these
provisions are effective in discouraging or preventing takeover attempts, they
may tend to reduce the market price for our stock.
Our common stock is not insured, so you could lose your total investment.
Our common stock is not a deposit or savings account, and is not
insured by the Federal Deposit Insurance Corporation or any other government
agency. Should our business fail, you could lose your total investment.
RISKS RELATED TO OUR INDUSTRY
We are subject to governmental regulation that could change and increase our
cost of doing business or have an adverse affect on our business.
We operate in a highly regulated industry and are subject to
examination, supervision and comprehensive regulation by various federal and
state agencies. Our compliance with the requirements of these agencies is costly
and may limit our growth and restrict certain of our activities, including
payment of dividends, mergers and acquisitions, investments, loans and interest
rates charged, and locations of offices. We are also subject to capitalization
guidelines established by federal authorities and our failure to meet those
guidelines could result, in an extreme case, in our Bank's being placed in
receivership. We are also subject to some of the extensive and expensive
requirements imposed on public companies by the Sarbanes-Oxley Act of 2002 and
related regulations.
Various laws, including the Federal Deposit Insurance Act and the
Emergency Economic Stability Act of 2008 ("EESA"), and related regulations are
structured to spread the governmental costs of problems in the financial
industry broadly over the financial industry in order to prevent the taxpayers
from having to pay such costs. As a result, assessments by the FDIC to pay for
deposit insurance have increased, and will likely continue to increase,
substantially, and the total our bank will be required to pay could increase
enough to materially affect our income and our ability to operate profitably.
Additionally, EESA contains a provision for the financial industry to be
required to absorb, in an as yet undetermined fashion, any losses suffered by
the government on account of its acquiring troubled assets under the Troubled
Assets Relief Program of EESA.
The laws and regulations applicable to the banking industry could
change at any time, particularly in light of recent developments in the economy
and the financial services industry, and we cannot predict the impact of these
changes on our business or profitability. Because government regulation greatly
affects the business and financial results of all commercial banks and bank
holding companies, our cost of compliance could adversely affect our ability to
operate profitably.
15
We are susceptible to changes in monetary policy and other economic factors
which may adversely affect our ability to operate profitably.
Changes in governmental, economic and monetary policies may affect the
ability of our Bank to attract deposits and make loans. The rates of interest
payable on deposits and chargeable on loans are affected by governmental
regulation and fiscal policy as well as by national, state and local economic
conditions. All of these matters are outside of our control and affect our
ability to operate profitably.
Item 1B. Unresolved Staff Comments.
Not applicable.
Item 2. Properties.
The Company owns 1.83 acres of land at 1670 East Main Street in Easley,
South Carolina where its main office and an operations center are located. The
Company also owns 6.197 acres of land in the 40 block of Farrs Bridge Road in
the Berea area of Greenville, South Carolina where a branch office is located
and .95 acres of land in the Powdersville area of Piedmont, South Carolina where
another branch is located.
Item 3. Legal Proceedings.
The Company may from time to time be a party to various legal
proceedings arising in the ordinary course of business, but management of the
Company is not aware of any pending or threatened litigation or unasserted
claims or assessments that are expected to result in losses, if any, that would
be material to the Company's business and operations.
Item 4. (Removed and Reserved).
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities.
The information set forth in the 2009 Annual Report to Shareholders
(the "2009 Annual Report") under the caption "Market for Common Equity and
Related Stockholder Matters," which is included in Exhibit 13 to this Annual
Report on Form 10-K, is incorporated herein by reference.
The information required by Item 201(d) of Regulation S-K is set forth
in Item 12 hereof.
During the quarter ended March 31, 2009, the Company issued 14,172
shares of its common stock to one director and one executive officer upon the
exercise of options, as reported in the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2009. Issuance of such shares was not registered
under the Securities Act of 1933 in reliance upon the exemption provided by
Section 4(2) thereof because the issuance did not involve a public offering. The
Company has not in the past year sold any other securities that were not
registered under the Securities Act of 1933.
Neither the Company nor any "affiliated purchaser" (as defined in 17
C.F.R. 240.10b-18(a)(3)) purchased any shares or units of any class of the
Company's equity securities that is registered pursuant to Section 12 of the
Exchange Act during the fourth quarter of 2009.
Item 6. Selected Financial Data.
Not applicable.
16
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The information set forth in the 2009 Annual Report under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," which is included in Exhibit 13 to this Annual Report on Form 10-K,
is incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
Item 8. Financial Statements and Supplementary Data.
The Consolidated Financial Statements and notes thereto and Report of
Independent Registered Public Accounting Firm set forth in the 2009 Annual
Report, which are included in Exhibit 13 to this Annual Report on Form 10-K, are
incorporated herein by reference.
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.
Not Applicable.
Item 9A(T) Controls and Procedures.
Disclosure Controls and Procedures
Based on the evaluation required by 17 C.F.R. Section 240.13a-15(b) or
240.15d-15(b) of the Company's disclosure controls and procedures (as defined in
17 C.F.R. Sections 240.13a-15(e) and 240.15d-15(e)), the Company's chief
executive officer and chief financial officer concluded that such controls and
procedures, as of the end of the year covered by this annual report, were
effective.
Management's Annual Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Exchange
Act Rule 13a-15(f). A system of internal control over financial reporting is a
process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles.
Under the supervision and with the participation of management,
including the principal executive officer and the principal financial officer,
the Company's management has evaluated the effectiveness of its internal control
over financial reporting as of December 31, 2009 based on the criteria
established in a report entitled "Internal Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission" and the
interpretive guidance issued by the Commission in Release No. 34-55929. Based on
this evaluation, the Company's management has evaluated and concluded that the
Company's internal control over financial reporting was effective as of December
31, 2009.
This annual report does not include an attestation report of the
Company's independent registered public accounting firm regarding internal
control over financial reporting because management's report was not subject to
attestation by the Company's registered public accounting firm pursuant to
temporary rules of the Securities and Exchange Commission that permit the
Company to provide only management's report in this annual report.
Changes in Internal Control Over Financial Reporting
The Company is continuously seeking to improve the efficiency and
effectiveness of its operations and of its internal controls. This results in
modifications to its processes throughout the Company. However, there has been
no change in its internal control over financial reporting that occurred during
the Company's most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
17
Item 9B. Other Information
No information was required to be disclosed in a report on Form 8-K
during the fourth quarter of 2009 that was not disclosed.
PART III
Item 10. Directors, Executive Officers and Corporate Governance.
The information set forth under the captions "Management of the
Company" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the
Company's Proxy Statement for the Annual Meeting of Shareholders to be held on
May 11, 2010 (the "2010 Proxy Statement") is incorporated herein by reference.
Code of Ethics
The Company has adopted a code of ethics (as defined by 17 C.F.R.
229.406) that applies to its principal executive officer and principal financial
officer. The Company will provide a copy of the code of ethics, free of charge,
to any person upon written request to Jennifer M. Champagne, Chief Financial
Officer, Cornerstone Bancorp, 1670 East Main Street, Easley, South Carolina
29640.
Audit Committee
The Company has a separately-designated standing Audit Committee
established in accordance with Section 3(a)(58)(A) of the Securities Exchange
Act of 1934. The Audit Committee is responsible for seeing that audits of the
Company are conducted annually. An independent registered public accounting firm
is employed for that purpose by the Board of Directors upon recommendation of
the Audit Committee. Reports on these audits are reviewed by the Committee upon
receipt and a report thereon is made to the Board at its next meeting. The Audit
Committee is comprised of Messrs. Gaston, Hooper, Hendricks, Spearman and Wike,
each of whom is independent as defined in the Nasdaq Rules. The Audit Committee
operates pursuant to a written charter.
Audit Committee Financial Expert
The Company's board of directors has determined that the Company does
not have an "audit committee financial expert," as that term is defined by Item
407(d)(5) of Regulation S-K promulgated by the Securities and Exchange
Commission, serving on its audit committee. The Company's audit committee is a
committee of directors who are elected by the shareholders and who are
independent of the Company and its management. After reviewing the experience
and training of all of the Company's independent directors, the board of
directors has concluded that no independent director meets the SEC's very
demanding definition. Therefore, it would be necessary to find a qualified
individual willing to serve as both a director and member of the audit committee
and have that person elected by the shareholders in order to have an "audit
committee financial expert" serving on the Company's audit committee. The
Company's audit committee is, however, authorized to use consultants to provide
financial accounting expertise in any instance where members of the committee
believe such assistance would be useful. Accordingly, the Company does not
believe that it needs to have an "audit committee financial expert" on its audit
committee.
Item 11. Executive Compensation.
The information set forth under the captions "Management Compensation"
and "Compensation of Directors" in the 2010 Proxy Statement is incorporated
herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
The information set forth under the caption "Security Ownership of
Certain Beneficial Owners and Management" in the 2010 Proxy Statement is
incorporated herein by reference.
Equity Compensation Plan Information
The following table sets forth information as of December 31, 2009
about all of the Company's compensation plans (including individual compensation
arrangements) under which equity securities of the Company are authorized for
issuance.
18
Number of securities Number of securities remaining
to be issued upon Weighted-average available for future issuance
exercise of exercise price of under equity compensation plans
outstanding options, outstanding options, (excluding securities reflected
Plan Category warrants and rights warrants and rights in column (a))
------------- ------------------- ------------------- --------------
(a) (b) (c)
Equity compensation
plans approved by
security holders ......... 106,255 $9.82 59,487
Equity compensation
plans not approved by
security holders ......... - - -
------- ------
Total .................... 106,255 59,487
======= ======
The equity securities shown in the table under "Equity compensation
plans approved by security holders" are stock options granted to employees and
directors pursuant to the 2003 Stock Option Plan. Further information about
these options is set forth in the 2010 Proxy Statement under the caption
"Management Compensation -- 2003 Stock Option Plan," and in Note 18 to the
Financial Statements included in Exhibit 13 to this Annual Report on Form 10-K.
Item 13. Certain Relationships and Related Transactions, and Director
Independence.
The information set forth under the captions "Certain Relationships and
Related Transactions," "Compensation of Directors - Organizers' Stock Warrants"
and "Governance Matters - Director Independence" in the 2010 Proxy Statement is
incorporated herein by reference. Each member of the Audit Committee and the
Human Resources (compensation) Committee is independent as defined by the Nasdaq
Stock Market Marketplace Rules. The entire Board of Directors serves as a
nominating committee, and not all members of the Board are independent as
defined by such rules.
Item 14. Principal Accountant Fees and Services
The information set forth under the caption "Registered Public
Accounting Firm" in the 2010 Proxy Statement is incorporated herein by
reference.
Item 15. Exhibits
(a) Exhibits, Financial Statement Schedules.
Financial Statements
The following financial statements are filed with this report:
- Report of Independent Registered Public Accounting Firm.
- Consolidated Balance Sheets as of December 31, 2009 and 2008.
- Consolidated Statements of Income (Loss) for the years ended December
31, 2009, 2008 and 2007.
- Consolidated Statements of Shareholders' Equity and Comprehensive
Income for the years ended December 31, 2009, 2008 and 2007.
- Consolidated Statements of Cash Flows for the years ended December 31,
2009, 2008 and 2007.
- Notes to Consolidated Financial Statements.
19
Exhibit No. Description
3.1 Articles of Incorporation of Registrant (1)
3.2 Bylaws of Registrant (1)
10.1 Form of Organizers' Option Agreements (2)
10.2 Cornerstone Bancorp 2003 Stock Option Plan (3)
10.3 Amended Change of Control Agreement between the Company and J. Roger
Anthony (4)
10.4 Form of Amended Change of Control Agreement between the Company and
each of Jennifer M. Champagne and Susan S. Jolly (4)
10.5 Form of Amendment to Endorsement Method Split Dollar Plan, dated as of
December 5, 2007, between the Company's wholly-owned subsidiary,
Cornerstone National Bank, and each of J. Rodger Anthony, Jennifer M.
Champagne and Susan S. Jolly (4)
13 Portions of 2009 Annual Report to Shareholders incorporated by
reference into this Form 10-K
21 Subsidiaries of Registrant
31-1 Rule 13a-14(a) Certifications
31-2 Rule 13a-14(a) Certifications
32 Section 1350 Certifications
-----------------
(1) Incorporated by reference to Registration Statement on Form SB-2 (No.
333-79543).
(2) Incorporated by reference to Annual Report on Form 10-KSB for the year
ended December 31, 1999.
(3) Incorporated by reference to Quarterly Report on Form 10-QSB for the
quarter ended June 30, 2003.
(4) Incorporated by reference to Report on Form 8-K filed December 6, 2007.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Cornerstone Bancorp
March 30, 2010 By: s/J. Rodger Anthony
----------------------------------------
J. Rodger Anthony
President and Chief Executive Officer
By: s/Jennifer M. Champagne
----------------------------------------
Jennifer M. Champagne
Chief Financial Officer
(Principal Financial and Principal
Accounting Officer)
20
Pursuant to the requirements of the Securities Exchange Act of 1934
this Report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
Signature Title Date
s/J. Rodger Anthony
-------------------------
J. Rodger Anthony President, Chief Executive Officer, Director March 30, 2010
-------------------------
Walter L. Brooks Director March __, 2010
s/Jennifer M. Champagne
-------------------------
Jennifer M. Champagne Chief Financial Officer , Director March 30, 2010
s/Janice E. Childress
-------------------------
Janice E. Childress Director March 30, 2010
s/J. Bruce Gaston
-------------------------
J. Bruce Gaston Director March 30, 2010
s/S. Ervin Hendricks, Jr.
-------------------------
S. Ervin Hendricks, Jr. Director March 30, 2010
s/Joe E. Hooper
-------------------------
Joe E. Hooper Director March 30, 2010
s/Susan S. Jolly
-------------------------
Susan S. Jolly Director March 30, 2010
s/Robert R. Spearman
-------------------------
Robert R. Spearman Director March 30, 2010
s/John M. Warren, Jr., M.D.
-------------------------
John M. Warren, Jr., M.D. Director March 30, 2010
s/George I. Wike, Jr.
-------------------------
George I. Wike, Jr. Director March 30, 2010
21
Exhibit Index
Exhibit No. Description
3.1 Articles of Incorporation of Registrant (1)
3.2 Bylaws of Registrant (1)
10.1 Form of Organizers' Option Agreements (2)
10.2 Cornerstone Bancorp 2003 Stock Option Plan (3)
10.3 Amended Change of Control Agreement between the Company and J. Roger
Anthony (4)
10.4 Form of Amended Change of Control Agreement between the Company and
each of Jennifer M. Champagne and Susan S. Jolly (4)
10.5 Form of Amendment to Endorsement Method Split Dollar Plan, dated as of
December 5, 2007, between the Company's wholly-owned subsidiary,
Cornerstone National Bank, and each of J. Rodger Anthony, Jennifer M.
Champagne and Susan S. Jolly (4)
13 Portions of 2009 Annual Report to Shareholders incorporated by
reference into this Form 10-K
21 Subsidiaries of Registrant
31-1 Rule 13a-14(a) Certifications
31-2 Rule 13a-14(a) Certifications
32 Section 1350 Certifications
-----------------
(1) Incorporated by reference to Registration Statement on Form SB-2 (No.
333-79543).
(2) Incorporated by reference to Annual Report on Form 10-KSB for the year
ended December 31, 1999.
(3) Incorporated by reference to Quarterly Report on Form 10-QSB for the
quarter ended June 30, 2003.
(4) Incorporated by reference to Report on Form 8-K filed December 6, 2007.
22