CORNERSTONE BANCORP/SC - FORM 10-Q

Attached files

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EX-32 - CORNERSTONE BANCORP/SC	cstn10q3_10ex32.htm
EX-31.1 - CORNERSTONE BANCORP/SC	cstn10q3_10ex31-1.htm
EX-31.2 - CORNERSTONE BANCORP/SC	cstn10q3_10ex31-2.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For The Quarterly Period Ended September 30, 2010

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For The Transition Period From _______________ To _________________.

Commission File Number 000-51950

CORNERSTONE BANCORP

(Exact name of registrant as specified in its charter)

South Carolina		57-1077978
(State or other jurisdiction of		(I.R.S. Employer Identification Number)
incorporation or organization)

1670 East Main Street, Easley, South Carolina 29640

(Address of principal executive offices)

(864) 306-1444

(Registrant's telephone number, including Area Code)

Not Applicable

(Former name, former address, and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes

[ ] 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 the Registrant)

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 definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [ ] Accelerated filer [ ]

Non-accelerated filer [ ](Do not check if a smaller reporting company) Smaller reporting company [X]

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

Indicate the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date:

Common Stock - No Par Value, 2,210,769 shares outstanding on November 2, 2010

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

CORNERSTONE BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

	September 30,			December 31,
	2010			2009
Assets	(Unaudited)

Cash and due from banks	$	9,847,163		$	4,369,596
Federal funds sold		5,120,000			1,670,000
Cash and cash equivalents		14,967,163			6,039,596

Investment securities
Available for sale		25,432,193			28,902,143
Other investments		1,089,150			1,142,050

Loans, net		121,904,963			135,067,914
Property and equipment, net		5,242,003			5,291,203
Cash surrender value of life insurance policies		1,891,312			1,838,663
Other real estate owned		8,340,361			6,712,948
Other assets		2,644,023			3,975,813
Total assets	$	181,511,168		$	188,970,330

Liabilities And Shareholders’ Equity

Liabilities
Deposits
Noninterest bearing	$	11,017,465		$	11,234,486
Interest bearing		136,462,907			141,146,788
Total deposits		147,480,372			152,381,274
Customer repurchase agreements		2,779,057			3,257,002
Borrowings from Federal Home Loan Bank of Atlanta		6,630,047			9,743,172
Broker repurchase agreements		5,000,000			5,000,000
Other liabilities		640,324			549,477

Total liabilities		162,529,800			170,930,925

Shareholders’ equity
Preferred stock, 10,000,000 shares authorized, 1,038 shares issued at September 30, 2010 and none issued at December 31, 2009		998,538			-
Common stock, no par value, 20,000,000 shares authorized, 2,210,769 shares at September 30, 2010 and 2,105,738 at December 31, 2009		18,844,619			18,799,728
Retained earnings (deficit)		(1,431,354	)		(921,014	)
Accumulated other comprehensive income		569,565			160,691

Total shareholders’ equity		18,981,368			18,039,405

Total liabilities and shareholders’ equity	$	181,511,168		$	188,970,330

The accompanying notes are an integral part of these consolidated financial statements.

CORNERSTONE BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(Unaudited)

	For the three months ended September 30,						For the nine months ended September 30,
	2010			2009			2010			2009
Interest and Dividend Income
Interest and fees on loans	$	1,720,881		$	1,722,059		$	5,265,757		$	5,230,366
Investment securities		231,689			267,048			732,351			757,071
Federal funds sold and interest bearing balances		5,165			3,546			12,227			10,880
Total interest income		1,957,735			1,992,653			6,010,335			5,998,317

Interest Expense
Deposits		563,851			709,667			1,813,410			2,225,544
Borrowings		113,181			123,354			323,662			369,139
Total interest expense		677,032			833,021			2,137,072			2,594,683

Net Interest Income		1,280,703			1,159,632			3,873,263			3,403,634
Provision for Loan Losses		180,000			945,000			1,080,000			2,025,000

Net interest income after provision for loan losses		1,100,703			214,632			2,793,263			1,378,634

Noninterest Income
Service charges on deposit accounts		133,580			154,258			398,132			424,982
Mortgage loan origination fees		-			25,781			-			136,843
Gain on sale of security		-			-			-			52,300
Loss on sale of repossessed collateral		(39,506	)		(10,616	)		(138,649	)		(35,369	)
Other		57,930			59,991			153,324			133,678
Total noninterest income		152,004			229,414			412,807			712,434

Noninterest Expense
Salaries and employee benefits		559,087			601,564			1,687,572			1,811,201
Premises and equipment		135,145			140,164			420,127			438,701
Data processing		58,779			53,882			172,921			164,757
Professional and regulatory fees		168,296			120,146			422,145			442,483
Supplies		16,294			16,335			50,393			51,691
Advertising		6,314			6,105			16,867			25,002
Other real estate owned expenses		482,850			38,365			703,989			57,002
Other		198,626			315,358			578,369			676,597
Total noninterest expense		1,625,391			1,291,919			4,052,383			3,667,434
Net loss before taxes		(372,684	)		(847,873	)		(846,313	)		(1,576,366	)
Income tax benefit		(125,219	)		(301,908	)		(335,973	)		(590,141	)
Net loss	$	(247,465	)	$	(545,965	)	$	(510,340	)	$	(986,225	)
Preferred stock dividend accumulated	$	(9,228	)		-		$	(9,228	)		-
Income available to common shareholders	$	(256,693	)	$	(545,965	)	$	(519,568	)	$	(986,225	)

Loss Per Share
Basic	$	(.12	)	$	(.25	)	$	(.24	)	$	(.45	)
Diluted	$	(.12	)	$	(.25	)	$	(.24	)	$	(.45	)
Weighted Average Shares Outstanding
Basic		2,210,769			2,211,024			2,210,769			2,207,236
Diluted		2,210,769			2,211,024			2,210,769			2,207,236

The accompanying notes are an integral part of these consolidated financial statements.

CORNERSTONE BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME

For the nine months ended September 30, 2010 and 2009

(Unaudited)

													Accumulated
										Retained			other		Total
	Preferred Stock				Common stock					earnings			comprehensive		shareholders’
	Shares		Amount		Shares		Amount			(deficit)			income (loss)		equity

Balance, December 31, 2008		-		-		1,991,565	$	18,323,333		$	765,906		$	47,708	$	19,136,947
Net loss		-		-		-		-			(986,225	)		-		(986,225	)
Other comprehensive income, net of income taxes
Unrealized gain on investment securities, net		-		-		-		-			-			482,780		482,780
Comprehensive loss		-		-												(503,445	)
Stock based compensation		-		-		-		54,348			-			-		54,348
Options exercised		-		-		14,172		80,000			-			-		80,000
Stock dividend declared (5%)		-		-		100,001		323,931			(325,646	)		-		(1,715	)

Balance, September 30, 2009		-	$	-		2,105,738	$	18,781,612		$	(545,965	)	$	530,488	$	18,766,135


Balance, December 31, 2009		-		-		2,105,738	$	18,799,728		$	(921,014	)	$	160,691	$	18,039,405
Net loss		-		-		-		-			(510,340	)		-		(510,340	)
Other comprehensive income, net of income taxes
Unrealized gain on investment securities, net		-		-		-		-			-			408,874		408,874
Comprehensive loss																(101,466	)
Stock based compensation		-		-		-		45,915			-			-		45,915
Stock dividend declared (5%), recorded as a stock split		-		-		105,031		(1,024	)		-			-		(1,024	)
Issuance of 8% cumulative perpetual preferred stock, net of expenses of $39,462		1,038	$	998,538		-		-			-			-		998,538

Balance, September 30, 2010		1,038	$	998,538		2,210,769	$	18,844,619		$	(1,431,354	)	$	569,565	$	18,981,368

The accompanying notes are an integral part of these consolidated financial statements.

CORNERSTONE BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	For the nine months ended September 30,
	2010			2009
Operating Activities
Net loss	$	(510,340	)	$	(986,225	)
Adjustments to reconcile net loss to net cash provided by operating activities
Depreciation and amortization		344,610			247,539
Provision for loan losses		1,080,000			2,025,000
Write-down of other real estate owned		425,506			-
Non-cash option expense		45,915			54,348
Gain on sale of property and equipment		-			(625	)
Loss on sale of property acquired in foreclosure		138,649			35,369
Gain on sale of security available for sale		-			(52,300	)
Changes in operating assets and liabilities
Change in interest receivable		94,102			93,693
Change in other assets		1,185,039			(1,453,305	)
Change in other liabilities		(119,785	)		71,539

Net cash provided by operating activities		2,683,696			35,033

Investing Activities
Proceeds from maturities and principal repayments of available for sale securities		7,046,916			5,065,417
Proceeds from sale of available for sale securities					1,052,300
Redemption (purchase) of FHLB and Federal Reserve stock		52,900			(27,900	)
Purchase of investment securities available for sale		(3,126,338	)		(10,198,378	)
Purchase of property and equipment		(126,532	)		(5,448	)
Proceeds from sale of property acquired in foreclosure		3,439,925			2,198,474
Capitalization of improvements to foreclosed property		(275,489	)		-
Proceeds from sale of property and equipment		-			625
Net (increase) decrease in loans to customers		6,726,947			(17,496,079	)

Net cash provided by (used for) investing activities		13,738,329			(19,410,989	)

Financing Activities
Net increase (decrease) in demand, savings and time deposits		(4,900,902	)		31,460,807
Net decrease in customer repurchase agreements		(477,945	)		(1,033,009	)
Cash paid in lieu of partial shares related to stock dividend		(1,024	)		(1,715	)
Decrease in federal funds purchased		-			(1,810,000	)
Repayment of FHLB advances		(3,113,125	)		(5,113,125	)
Borrowings from FHLB		-			4,500,000
Proceeds from sales of preferred stock, net		998,538			-
Proceeds from exercise of stock options		-			80,000

Net cash provided by (used for) financing activities		(7,494,458	)		28,082,958
Net increase in cash and cash equivalents		8,927,567			8,707,002
Cash and Cash Equivalents, Beginning of Period		6,039,596			3,960,227

Cash and Cash Equivalents, End of Period	$	14,967,163		$	12,667,229

Supplemental Information
Cash paid for interest	$	699,060		$	2,621,816
Cash paid for income taxes	$	-		$	60,127
Non-cash Supplemental Information
Loans transferred to other real estate owned	$	5,356,004		$	4,479,462
Loans charged-off, net	$	857,452		$	1,680,936

The accompanying notes are an integral part of these consolidated financial statements.

CORNERSTONE BANCORP AND SUBSIDIARY

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Business and Basis of Presentation

Summary of Significant Accounting Principles

A summary of significant accounting policies is included in the Cornerstone Bancorp (the “Company”) 2009 Annual Report to Shareholders, which also contains the Company's audited financial statements for 2009 and is also included in the Form 10-K for the year ended December 31, 2009.

Principles of Consolidation

The consolidated financial statements include the accounts of Cornerstone Bancorp, the parent company, and Cornerstone National Bank (the “Bank”), its wholly owned subsidiary, and Crescent Financial Services, Inc., a wholly owned subsidiary of the Bank. All significant intercompany items have been eliminated in the consolidated statements. Certain amounts have been reclassified to conform to current year presentation.

Management Opinion

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q. Accordingly they do not contain all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The financial statements in this report are unaudited. In the opinion of management, all adjustments necessary to present a fair statement of the results for the interim period have been made. Such adjustments are of a normal and recurring nature. The results of operations for any interim period are not necessarily indicative of the results to be expected for an entire year. These interim financial statements should be read in conjunction with the annual financial statements and notes thereto contained in the 2009 Annual Report on Form 10-K.

Note 2. Earnings per Share

FASB ASC 260, "Earnings per Share," requires that the Company present basic and diluted net income (loss) per common share. The assumed conversion of stock options creates the difference between basic and diluted net income per share. Income per share is calculated by dividing net income by the weighted average number of common shares outstanding for each period presented. The weighted average number of common shares outstanding for basic and diluted net loss per common share for the three month period ended September 30, 2010 was 2,210,769 shares. Outstanding options were excluded from the loss per share calculation as they are anti-dilutive as of September 30, 2010. The calculation of earnings per share includes the effect of the 5% stock dividend declared on April 13, 2010 as if it had been declared on January 1, 2010. The weighted average number of common shares outstanding for basic and diluted net loss per common share for the nine month period ended September 30, 2010 was 2,210,769 shares.

Note 3. Stock Based Compensation

As described in Notes 1 and 18 to the financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, the Company has a stock-based employee and director compensation plan, which was approved by shareholders in 2003 (the “2003 Plan”).

There have been no options granted in 2010 under the 2003 Plan. Refer to the notes to the financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for further information.

For the nine months ended September 30, 2010, the Company expensed $12,219 related to options granted in 2009, $12,891 related to options granted in 2008, $12,891 related to options granted in 2007, and $7,914, related to options granted in 2006. For the three months ended September 30, 2010, the Company expensed $15,305 related to options. The expense is included in salaries and employee benefits in the accompanying consolidated statements of income.

Prior to adopting the provisions of FASB ASC 718 the Company accounted for stock option awards under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. These awards are fully vested, and no compensation expense has been recognized related to these option awards. Following the 5% stock dividend declared on April 13, 2010, the total number of options outstanding was adjusted to approximately 111,565 and the weighted average exercise price was adjusted to $9.99 per share, as provided for in the 2003 Plan.

Note 4. Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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 interest and noninterest income and expenses during the reporting period. Actual results could differ from those estimates. The primary significant estimate in the accompanying consolidated financial statements is the allowance for loan losses. A discussion of the significant factors involved in estimating the allowance for loan losses is included in this Form 10-Q in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the section titled “Results of Operations” and in the Company’s 2009 Form 10-K. The provision for income taxes and the valuation of other real estate owned are also considered significant estimates.

Note 5. Concentrations of credit risk

The Bank makes loans to individuals and small businesses located primarily in upstate South Carolina for various personal and commercial purposes. The Bank monitors the portfolio for concentrations of credit on a quarterly basis using North American Industry Codes, (“NAIC”) and using definitions required by regulatory agencies. The Bank has loans in two NAIC categories of which each represents more than 10% of the portfolio. The NAIC concentrations are 17.25% in Residential Building Construction and 21.6% in Real Estate Rental and Leasing. The portfolio also has loans representing 21 other NAIC categories.

The Bank has concentrations in loans collateralized by real estate according to the regulatory definition. Included in this segment of the portfolio is the category for construction and development loans. While the Bank does have a concentration of loans in this category, the Bank’s business is managed in a manner intended to help reduce the risks normally associated with construction lending. Management requires lending personnel to visit job sites, maintain frequent contact with borrowers and perform or commission inspections of completed work prior to issuing additional construction loan draws. Under current policy, loans are limited to 80% of cost of construction projects, and borrowers are required to meet minimum net worth requirements and debt service coverage ratios. Projects for construction of single family homes are generally limited to those projects with contracts for sale where the ultimate owner has a significant investment in the contract. These policies may be considered stricter than policies in place when some of the Bank’s currently outstanding loans were originated. However, as loans mature or as new loans are made, the current guidelines described above would be used to underwrite construction loans.

The Bank does not make long term (more than 15 years) mortgage loans to be held in its portfolio, does not offer loans with negative amortization features or long-term interest only features, or loans with loan to collateral value ratios in excess of 100% at the time the loan is made. The Bank does offer loan products with features that can increase credit risk during periods of declining economic conditions, such as adjustable rate loans, short-term interest-only loans, and loans with amortization periods that differ from the maturity date (i.e., balloon payment loans). However, the Bank evaluates each customer’s creditworthiness based on the customer’s individual circumstances, and current and expected economic conditions, and underwrites and monitors each loan for associated risks. Loans made with exceptions to internal loan guidelines and those with loan-to-value ratios in excess of regulatory loan-to-value guidelines are monitored and reported to the Board of Directors on a monthly basis. The regulatory loan-to-value guidelines permit exceptions to the guidelines up to a maximum of 30% of total capital for commercial loans and exceptions for all types of real estate loans up to a maximum of 100% of total capital. As of September 30, 2010, the Bank has $9.2 million of loans which exceed the regulatory loan to value guidelines. This amount is within the maximum allowable exceptions to the guidelines. Of the $9.2 million of loans with exceptions to the regulatory loan to value guidelines, $7.4 million or 80% were not exceptions at the time the loans were made, but became exceptions upon reappraisal. Management routinely reappraises real estate collateral based on specific criteria and circumstances. If additional collateral is available, the Bank may require the borrower to commit additional collateral to the loan or take other actions to mitigate the Bank’s risk.

Note 6. Income taxes

The Company accounts for income taxes using a method whereby certain items of income and expense (principally provision for loan losses, depreciation, and prepaid expenses) are included in one reporting period for financial accounting purposes and another for income tax purposes. Refer to the notes to the Company’s consolidated financial statements for the year ended December 31, 2009 for more information. To date in 2010, the Company recorded an income tax benefit of $335,793 compared to tax benefit of $590,141 in the first three quarters of 2009. The primary reasons for the benefit in 2010 and 2009 is recording the future benefit of the net operating loss. As of September 30, 2010 management has evaluated its deferred tax items and does not believe that any require reserves as of September 30, 2010 because the majority relate to temporary differences associated with the allowance for loan losses. The Company also believes that its income tax filing positions taken or expected to be taken in its tax returns will more likely than not be sustained upon audit by the taxing authorities, and does not anticipate any adjustments that will result in a material adverse impact on the Company’s financial condition, results of operations, or cash flows. Therefore, no reserves for uncertain income tax positions have been recorded pursuant to ASC 740, “Income Taxes”.

Note 7. Fair Value Accounting

Effective January 1, 2008, the Company adopted an accounting standard which expands disclosures about fair value measurements used in the financial statements. The standard defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The standard also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1-Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as U.S. Treasuries and money market funds.

Level 2-Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt with quoted prices that are traded less frequently than exchange-traded instruments, mortgage-backed securities, municipal bonds, corporate debt securities, and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes certain derivative contracts and impaired loans.

Level 3-Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. For example, this category generally includes certain private equity investments, retained residual interests in securitizations, residential mortgage servicing rights, and highly-structured or long-term derivative contracts.

During the quarter ended September 30, 2010, there were no significant transfers of assets between categories.

Note 8. 8% Cumulative Perpetual Preferred Stock

During the third quarter of 2010, the Company offered up to $2,500,000 of 8% Series A Cumulative Perpetual Preferred Stock (“the Preferred”) to accredited investors and up to 35 non-accredited investors. The Preferred was offered by Company’s directors and executive officers, and no selling agents or underwriters were used. 1,038 shares of the Preferred were sold. Proceeds of the offering, net of offering expenses totaled $998,538. The Preferred is scheduled to pay a dividend quarterly.

Note 9. Evaluation of subsequent events

In accordance with the accounting standard regarding subsequent events, management performed an evaluation to determine whether or not there have been any subsequent events since the balance sheet date that would be required to be included in these financial statements and concluded that there were none.

Note 10. Recently issued accounting standards

The following is a summary of recent authoritative pronouncements that may affect accounting, reporting, and disclosure of financial information by the Company:

The FASB issued ASU 2009–05, “Fair Value Measurements and Disclosures (Topic 820) – Measuring Liabilities at Fair Value” in August, 2009 to provide guidance when estimating the fair value of a liability. When a quoted price in an active market for the identical liability is not available, fair value should be measured using (a) the quoted price of an identical liability when traded as an asset; (b) quoted prices for similar liabilities or similar liabilities when traded as assets; or (c) another valuation technique consistent with the principles of Topic 820 such as an income approach or a market approach. If a restriction exists that prevents the transfer of the liability, a separate adjustment related to the restriction is not required when estimating fair value. The ASU was effective October 1, 2009 for the Company and had no impact on financial position or operations.

In January 2010, fair value guidance was amended to require disclosures for significant amounts transferred in and out of Levels 1 and 2 and the reasons for such transfers, and to require that gross amounts of purchases, sales, issuances and settlements be provided in the Level 3 reconciliation. The new disclosures are effective for the Company for the current quarter and have been reflected in Note 7 above.

Guidance related to subsequent events was amended in February 2010 to remove the requirement for an SEC filer to disclose the date through which subsequent events were evaluated. The amendments were effective upon issuance and had no significant impact on the Company’s financial statements.

The FASB issued ASU No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” in July, 2010. This ASU amends Accounting standards Codification Topic 310, “Receivables”, and requires expanded disclosures about the credit quality of an entity’s loan, lease, and other financing receivables and its related allowance for credit losses. The ASU is effective for periods ending after December 31, 2010 for additional disclosures required as of the end of a reporting period. For disclosures about activity that occurs during a reporting period, the ASU is effective for interim and annual periods beginning after December 31, 2010. The Company is required to begin to comply with the disclosures in its financial statements for the year ended December 31, 2010. The ASU is not expected to have any impact on the Company’s financial position or operations.

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which significantly changes the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes several provisions that will affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the future. Among other things, these provisions abolish the Office of Thrift Supervision and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of federal deposit insurance coverage, and impose new capital requirements on bank and thrift holding companies. The Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will be given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks. Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting originator compensation, minimum repayment standards, and pre-payments. Management is actively reviewing the provisions of the Dodd-Frank Act and assessing its probable impact on our business, financial condition, and results of operations.

Accounting standards that have been issued or proposed by the FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.

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:

·	future economic and business conditions;

·	the Company’s growth and ability to maintain growth;

·	governmental monetary and fiscal policies;

·	legislative and regulatory changes;

·	actions taken by regulatory authorities;

·	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;

·	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;

·	the effect of agreements with regulatory authorities, which restrict various activities and impose additional administrative requirements without commensurate benefits;

·	credit risks;

·	higher than anticipated levels of defaults on loans;

·	perceptions by depositors about the safety of deposits;

·	failure of our customers to repay loans;

·	failure of assumptions underlying the establishment of the allowance for loan losses, including the value of collateral securing loans;

·	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;

·	changes in accounting policies, rules, and practices;

·	cost and difficulty of implementing changes in technology or products;

·	loss of consumer confidence and economic disruptions resulting from terrorist activities;

·	ability to continue to weather the current economic downturn;

·	loss of consumer or investor confidence; and

·	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 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 the Bank’s website included in, or incorporated by reference into, this report are for information purposes only, and are not intended to incorporate the website by reference into this report.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation

General

Cornerstone Bancorp, (the “Company”) is a bank holding company and has no operations other than those carried on by its wholly owned subsidiary, Cornerstone National Bank (the “Bank”). The Bank commenced business in 1999, and conducts a general banking business from three offices in the Easley area of Pickens County, in the Berea area of Greenville County, and in the Powdersville area of Anderson County, South Carolina. In 2004, the 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.

Effect of Economic Trends

Since the fourth quarter of 2008, the Federal Deposit Insurance Corporation (“FDIC”), the Federal Reserve, the Department of the Treasury and Congress have taken a number of actions designed to alleviate or correct 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. The FDIC also implemented in October, 2008, a Transaction Account Liquidity Guarantee Program pursuant to which all noninterest-bearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account. The program has been made law by the Dodd-Frank Act but will expire after December 31, 2012.

An unfortunate consequence of the difficulties that have beset the banking industry in the last two years has been a large increase in bank failures, which has led to substantial claims being made against the FDIC’s Deposit Insurance Fund. In order to increase the amount in the Deposit Insurance Fund to reflect the increased risk of additional bank failures and insurance claims, the FDIC has raised its assessments on banks. The FDIC also required FDIC insured institutions to prepay the premiums for the years 2010, 2011, and 2012 on December 30, 2009. There can be no assurance that additional payments in the form of special assessments or higher premiums will not be required in the future as the FDIC’s Deposit Insurance Fund absorbs losses resulting from failed institutions. The Bank expensed $92,371 for FDIC insurance premiums during the third quarter of 2010.

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. In July 2010, Congress passed the Dodd-Frank Act, which will fundamentally overhaul the regulation of the financial services industry and impose extraordinary burdens on traditional banks. The bill raises many issues for banks and savings associations, the details of which remain to be drafted by regulatory agencies. 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 for community banks. However, one positive aspect of the legislation is that it permanently increased the FDIC’s deposit insurance limit to $250,000 per individual per institution for all types of deposit accounts.

Throughout 2008, 2009 and 2010, the Federal Open Market Committee of the Federal Reserve (“FOMC”) has held its target short-term interest rates at very low levels by historical standards. The FOMC has done this as part of its response to the economic turmoil currently dominating the U.S. economy. Management expects that the net interest margin will improve over the remainder of 2010 if certain assumptions regarding the level of interest earning assets are determined to be accurate. However, the Company and the Bank may be exposed to interest rate risk if market interest rates increase or decrease significantly in a short period of time. Management monitors interest rate risk, but if one or more of its assumptions regarding the timing or magnitude of changes in balances or interest rates proves to be incorrect, the Company’s interest margin, and its profitability could be impacted. Additionally, if the real estate markets and unemployment levels in South Carolina do not improve in the near future, the Company could face additional growth in nonperforming assets.

The current outlook for the national economy in the United States remains very cautiously positive. Even so, management expects that economic conditions will continue to adversely affect financial companies throughout the remainder of 2010 and possibly 2011. Specifically, unemployment is expected to remain high in the near term, and the real estate markets will only improve slowly. We will continue to monitor both the local and national economic conditions in an effort to minimize any negative impact on the Company.

Results of Operations for the Three Months Ended September 30, 2010 and 2009

Summary

The Company recorded a loss of $247,465 during the third quarter of 2010 or $ (.12) per share compared to a loss of $545,965 during the third quarter of 2009 or $(.25) per share, after giving effect to the five percent stock dividend (recorded as a stock split) declared in 2010. The primary reason for the improvement was a decrease in the quarterly provision for loan losses and an improvement in the net interest margin. This was partially offset by the absence of mortgage loan origination fees in 2010 compared to the third quarter of 2009. The Bank experienced a net increase in noninterest expense for the quarter in 2010 compared to 2009. The increase related to expenses and write-downs associated with other real estate owned. The Company decreased its expenditures for salaries and benefits, premises and equipment expenses, and other expenses, but it had increased expenses for professional and regulatory fees.

Net Interest Income

Net interest income is the primary driver of net income for the Company. Net interest income is equal to the difference between interest income earned on the Company’s interest earning assets and the interest paid on its interest bearing liabilities. The Company’s net interest margin increased to 3.17% in the third quarter of 2010 from 2.63% in the third quarter of 2009. The primary reason for the increase in the net interest margin was a decrease in the average rate paid on interest bearing liabilities. For the quarter ended September 30, 2010 the Bank paid an average of 1.75% on interest bearing liabilities, compared with an average of 2.14% on interest bearing liabilities in the 2009 quarter. The decrease was primarily attributable to the replacement of maturing higher rate deposits with lower rate deposits.

The table below illustrates the average balances of interest earning assets and interest bearing liabilities and the resulting annualized yields and costs for the three month periods ended September 30, 2010 and 2009.

	September 30, 2010							September 30, 2009
	Average Balance		Interest		Average Yield/ Cost			Average Balance		Interest		Average Yield/ Cost
Investments	$	27,146,989	$	231,689		3.39	%	$	25,147,390	$	267,048		4.21	%
Federal Funds Sold		14,002,032		5,165		.15	%		9,583,410		3,546		.15	%
Loans, excluding nonaccruals		116,682,151		1,720,881		5.85	%		131,176,743		1,722,059		5.21	%


Total interest earning assets		157,831,172		1,957,735		4.92	%		165,907,543		1,992,653		4.77	%

Interest bearing transaction accounts		12,603,195		14,320		.45	%		13,280,845		15,817		.47	%
Savings and money market		50,524,150		180,400		1.42	%		37,792,204		178,750		1.88	%
Time deposits		74,324,647		369,131		1.97	%		85,524,789		515,100		2.39	%
Total interest bearing deposits		137,451,992		563,851		1.63	%		136,597,838		709,667		2.06	%
Customer repurchase agreements and Federal Funds purchased
Customer repurchase agreements and Federal Funds purchased		2,814,282		8,019		1.13	%		3,672,218		16,089		1.74	%
Borrowings from FHLB Atlanta		7,905,243		60,645		3.04	%		9,507,173		62,747		2.62	%
Broker repurchase agreements		5,000,000		44,517		3.53	%		5,000,000		44,518		3.53	%
Total interest bearing liabilities	$	153,171,517		677,032		1.75	%	$	154,777,229		833,021		2.14	%

Net interest income			$	1,280,703						$	1,159,632
Interest rate spread						3.17	%						2.63	%
Interest margin						3.22	%						2.77	%

The Bank, which accounts for all of the Company’s sensitivity to changes in interest rates, measures interest sensitivity using various methods. Using a static GAP measurement, which compares the amount of interest sensitive assets repricing within a one year time period as compared to the amount of interest sensitive liabilities repricing within the same time frame, the Bank’s sensitivity to changes in interest rates can be analyzed. This method does not take into account loan prepayments and other non-contractual changes in balances and the applicable interest rates, but it does give some information as to possible changes in net interest income that could be expected simply as a result of changes in interest rates. As of September 30, 2010, the Bank’s cumulative static GAP ratio was .59 through 12 months assuming all non-maturing deposits reprice immediately and that all securities reprice in the year of their maturity, without regard to calls or principal reductions on mortgage-backed securities. This indicates a liability-sensitive position as of September 30, 2010. However, this measurement is based on assumptions about the repricing of various accounts, which may not occur as they have been modeled. Assuming some non-maturing deposits reprice in periods other than the first twelve months, and accounting for principal reductions on mortgage-backed securities, the Bank’s cumulative static GAP ratio is .92 through 12 months.

Based on a static GAP measurement, in a period of rising interest rates, asset-sensitive balance sheets would normally be expected to experience a widening of the net interest margin, while liability-sensitive balance sheets such as the Bank’s would normally be expected to experience pressure on the net interest margin. In a period of decreasing interest rates, liability-sensitive balance sheets would normally be expected to experience a widening of the net interest margin and asset-sensitive balance sheets would normally be expected to experience the opposite effect. Various market factors can, however, affect the net interest margin and cause it to react differently to changes in interest rates than would normally be expected under the static GAP model.

Provision for loan losses

For the quarter ended September 30, 2010, the Company expensed $180,000 to the provision for loan losses. The Bank sets the allowance for loan loss levels in response to trends in the portfolio and the level of potential problem loans. During the quarter, charge-offs totaled $93,545 and there were no recoveries.

Management has sought to provide the amount estimated to be necessary to maintain an allowance for loan losses that is adequate to cover the level of loss that management believes to be inherent in the portfolio as a whole, taking into account the Company’s experience, economic conditions and information about borrowers available at the time of the analysis. However, management believes further deterioration of economic conditions in the Company's market areas in the short-term is possible, especially with respect to real estate related activities and real property values. Consequently, management expects that further increases in provisions for loan losses could be needed in the future. See “Balance Sheet Review- Loans” for additional information on the Company’s loan portfolio and allowance for loan losses.

Noninterest income

The primary recurring drivers of noninterest income for the Company and the Bank are service charges on deposit accounts. Prior to the third quarter of 2009, mortgage loan origination fees also played an important role. For the three months ended September 30, 2010, the Company earned $133,580 in service charges on deposit accounts compared to $154,258 for the same period in 2009. During the turmoil in the residential mortgage markets over the last 18 months when national mortgage lenders changed or deleted programs and tightened credit standards and when the appraisal process became time-consuming and difficult, mortgage origination fees declined. The Company temporarily suspended its conventional mortgage origination department in the fourth quarter of 2009. When the market for conventional mortgages returns, management plans to reevaluate the possibility of offering long-term mortgage loans to its customers. Mortgage loan origination fees in the third quarter of 2009 were $25,781 and there were none in the third quarter of 2010. Other noninterest income was relatively unchanged in the third quarter of 2010 at $57,930 compared to $59,991 for the third quarter of 2009. The Company incurred losses on the sale of foreclosed properties in the third quarter of 2010 in the amount of $39,506, as compared to losses of $10,616. In 2009 the Company had losses on repossessed collateral sales of $10,616 during the third quarter of 2009.

Noninterest expense

Noninterest expense totaled $1.6 million for the three months ended September 30, 2010 and $1.3 million for the three months ended September 30, 2009. Expense related to other real estate owned increased $444,485 in the third quarter of 2010 over the 2009 third quarter levels, primarily due to write-downs of values of four properties owned as a result of foreclosure. The write-downs totaled $412,705 during the third quarter. The remainder of the other real estate expense of $482,850 is related to other costs associated with maintaining the properties owned by the bank. As other real estate is sold, these expenses are expected to decline. The increase was partially offset by a $42,477 decrease in salaries and employee benefits and a decrease of $116,732 in other expense. The decrease in other expenses was primarily related to a decrease in loan expenses. Loan expenses include costs associated with loan collections prior to receiving title to any foreclosed collateral. Expenses following foreclosure are included in other real estate owned expenses. Professional and regulatory fees increased as a result of increases in deposit insurance premiums and regulatory fees.

Results of Operations for the Nine Months Ended September 30, 2010 and 2009

Summary

The Company’s net loss for the nine months ended September 30, 2010 was $510,340 or ($.24) per share, compared to a loss of $986,225 or ($.45) per share for the nine months ended September 30, 2009 (including the effect of the five percent stock dividend declared in 2010, which was recorded as a stock split). The decrease in the net loss is due to improvements in the net interest margin and a decrease in the provision for loan losses, partially offset by lower noninterest income and higher noninterest expense.

Net Interest Income

Net interest income was $3.9 million in the first nine months of 2010 compared to $3.4 million for the nine months ended September 30, 2009. The increase was the result of improvements in the Bank’s net interest margin. The greatest positive impact on the Bank’s interest margin was a result of decreases in rates paid on interest-bearing liabilities. Average rates paid on interest bearing liabilities decreased by 51 basis points to 1.82% from 2.33%. The decrease was primarily attributable to replacement of maturing higher rate deposits with lower rate deposits.

The Bank’s interest earning assets decreased slightly over September 30, 2009 levels. The primary reductions were in loans receivable. The average rate earned on all interest earning assets for the nine months ended September 30, 2010 was 4.96% compared to 4.91% for the nine months ended September 30, 2009.

The table below illustrates the average balances of interest earning assets and interest bearing liabilities and the resulting annualized yields and costs for the nine month periods ended September 30, 2010 and 2009.

September 30, 2010

September 30, 2009

Average

Balance

Interest

Earned

Average

Yield/Cost

Average

Balance

Interest

Earned

Average

Yield/Cost

Investments	$	27,574,716	$	732,351	3.55	%	$	22,434,970	$	757,071	4.51	%
Federal Funds Sold		12,466,917		12,227	.13	%		9,648,247		10,880	.15	%
Loans		122,088,939		5,265,757	5.77	%		131,215,566		5,230,366	5.33	%
Total interest earning assets		162,130,572		6,010,335	4.96	%		163,298,783		5,998,317	4.91	%

Interest bearing transaction accounts		12,885,171		44,663	.46	%		13,116,268		58,784	.60	%
Savings and money market accounts		50,233,872		588,388	1.57	%		30,792,513		435,538	1.89	%
Time deposits		77,324,499		1,180,359	2.04	%		87,898,317		1,731,222	2.63	%

Total interest bearing deposits		140,443,542		1,813,410	1.73	%		131,807,098		2,225,544	2.26	%
Customer repurchase agreements and Federal Funds Purchased		2,841,276		30,424	1.43	%		3,959,807		62,257	2.10	%
Advances from FHLB		8,511,470		160,653	2.52	%		8,153,049		174,780	2.87	%
Broker repurchase agreements		5,000,000		132,585	3.55	%		5,000,000		132,102	3.53	%
Total interest bearing liabilities	$	156,796,288		2,137,072	1.82	%	$	148,919,954		2,594,683	2.33	%

Net interest income			$	3,873,263					$	3,403,634
Interest rate spread					3.13	%					2.58	%
Interest margin					3.19	%					2.79	%

Provision for loan losses

The amount of the Company’s provision for loan losses for the nine months ended September 30, 2010 was $1,080,000 compared to $2,025,000 for the nine months ended September 30, 2009. Charge-offs totaled $857,452 during the first nine months of 2010 compared to $1,681,436 for the first nine months of 2009. As of September 30, 2010 there were 27 loans past due over 30 days, as compared with 50 loans past due more than 30 days as of September 30, 2009. These numbers include 13 loans on nonaccrual in 2010 and 31 loans on nonaccrual in 2009. Recoveries totaled $500 as of September 30, 2009. See “Balance Sheet Review- Loans” for additional information on the Company’s loan portfolio and allowance for loan losses.

Noninterest income

Noninterest income for the nine months ended September 30, 2010 was $412,807 compared to $712,434 for the nine months ended September 30, 2009. As discussed above, mortgage loan origination fees declined year over year due to the closure of the department in the fourth quarter of 2009. Mortgage origination fees were $136,843 in the first nine months of 2009 and there were none in 2010. Other income in the first nine months of 2009 also included a gain on the sale of an available for sale security in the amount of $52,300. Losses on repossessed collateral increased in the 2010 period to $138,649 from $35,369 in the first nine months of 2009. Other real estate owned totaled $8.3 million as of September 30, 2010 and $6.7 million as of December 31, 2009. As nonperforming loans have moved through the foreclosure process, the Company has listed the properties for sale with professional real estate agents at market prices. The Company has sold assets totaling over $3.6 million in 2010. Due to the significant costs associated with holding properties for long periods of time, the Company has chosen to sell properties if possible, even if a loss is incurred after selling costs are paid. Thus additional losses on sales of other real estate owned are possible. The Company continues to evaluate the real estate market and the holding costs associated with each property, and may incur losses on sales in the future in order to avoid holding costs and higher levels of nonperforming assets.

Noninterest expense

Total noninterest expense for the nine months ended September 30, 2010 and 2009 were $4.1 million and $3.7 million, respectively. However, the composition of noninterest expense changed in 2010 compared to 2009. Salaries decreased $123,629 or 6.8% in the first nine months of 2010 compared to 2009 levels. The decrease reflects the decrease in commissions paid to mortgage loan officers as well as retirements, partially offset by annual salary increases and increases in the cost of providing benefits. Other expenses year to date in 2010 decreased by 14.5% in comparison to the first nine months of 2009. Other expense includes the costs of foreclosure prior to acquisition of title to foreclosed assets, including reappraisal costs that cannot be passed on to a customer, loan-related legal expenses, and property taxes paid prior to gaining title to real estate or other collateral. Increases in other real estate owned expenses offset declines in other noninterest expense categories as the cost to maintain properties acquired in foreclosure climbed. These expenses, including write-downs of value totaled $703,989 for the first nine months of 2010, compared to $57,002 for the first nine months of 2009. As the number of properties sold exceeds the number of properties foreclosed over the next twelve months, the costs are expected to decline.

Balance Sheet Review

Investments

At September 30, 2010, the Bank held available for sale securities with a fair value of $25.4 million and other investments with an amortized cost of $1.1 million. Available for sale securities include government sponsored enterprise bonds, mortgage-backed securities, and municipal bonds. The fair values of the Company’s available for sale investments, other than municipal bonds, are measured on a recurring basis using quoted market prices in active markets for identical assets and liabilities (“Level 1 inputs” under FASB ASC 820). Due to the lower level of trading activity in municipal bonds, the fair market values of these investments are measured based on other inputs such as inputs that are observable or can be corroborated by observable market data for similar assets with substantially the same terms (“Level 2 inputs” under FASB ASC 820). We obtain our fair value information via our bond accounting vendor. This vendor obtains municipal bond market pricing from Interactive Data, a provider of third-party financial market data. The Company does not adjust market pricing received from this vendor, but we do request that a qualified analyst review each municipal bond in the portfolio to determine if any other information is available that would call into question the market values used.

Other investments include stock in the Federal Home Loan Bank of Atlanta and the Federal Reserve Bank. These stocks are held at amortized cost because they have no quoted market value and have historically been redeemed at par value. However, there can be no assurance that these stocks will, in fact, be redeemed at cost in the future.

As of September 30, 2010, investments available for sale had a net unrealized gain of $862,856. As of September 30, 2010, we held one investment in an unrealized loss position.

Loans

The following table summarizes the composition of our loan portfolio.

	September 30, 2010						December 31, 2009

	Amount			% of Loans			Amount			% of Loans
Commercial and industrial	$	12,543,573			10.0	%	$	13,418,581			9.8	%
Real Estate – construction		45,810,758			36.7			53,827,245			39.1
Real Estate – mortgage
1-4 family residential		20,333,211			16.3			23,284,692			16.9
Nonfarm, nonresidential		42,203,726			33.8			41,810,020			30.3
Multifamily residential		1,799,180			1.4			2,520,201			1.8
Consumer installment		694,396			.6			1,346,807			1.0
Other Loans		1,438,004			1.2			1,555,705			1.1
Total Loans		124,822,848			100.0	%		137,763,251			100.0	%
Less allowance for loan losses		(2,917,885	)					(2,695,337	)
Net Loans	$	121,904,963					$	135,067,914

Activity in the allowance for loan losses for the first nine months of 2010 and 2009 is presented below.

	Nine months ended September 30, 2010			Nine months ended September 30, 2009

Allowance for loan losses, beginning of year	$	2,695,337		$	1,698,563
Provision for losses		1,080,000			2,025,000
Charge-offs		(857,452	)		(1,681,436	)
Recoveries		-			500
Allowance for loan losses, end of period	$	2,917,885		$	2,042,627

	As of or for the nine		As of or for the nine
	months ended		months ended
	September 30, 2010		September 30, 2009
Nonperforming loans to gross loans at end of period	7.63	%	5.71	%
Net charge-offs to average loans outstanding	(.66	%)	(1.22	%)
Net charge-offs to loans at end of period	(.69	%)	(1.20	%)
Allowance for loan losses to average loans	2.23	%	1.48	%
Allowance for loan losses to loans at end of period	2.34	%	1.45	%
Net charge-offs to allowance for loan losses	(29.39	%)	(82.29	%)
Net charge-offs to provision for loan losses	(79.39	%)	(83.00	%)

Charge-offs totaled $857,452 for the first nine months of 2010. Of the total net charge-offs in 2010, 80.9% related to construction loans, and 19.1% related to other loan types. Nonperforming loans as a percentage of loans outstanding increased over September 2009 levels. However, the number of nonperforming loans has decreased and the outstanding balance of loans also decreased by 11.2% in 2010.

Loans which management identifies as impaired generally will be nonperforming loans or restructured loans. Nonperforming loans include nonaccrual loans or loans which are 90 days or more delinquent as to principal or interest payments. As of September 30, 2010, the Bank had nonaccrual loans of $9.5 million representing 13 loans, a decrease of $219,564 from December 31, 2009. With the exception of one loan in the amount of $1.0 million, these loans are secured by real estate. In addition to loans on nonaccrual, as of September 30, 2010, management considers another $269,913 of loans impaired. Management routinely assesses the collateral and other circumstances associated with impaired loans in an effort to determine the amount of potential impairment. These loans are currently being carried at management’s best estimate of net realizable value, although no assurance can be given that no further losses will be incurred on these loans until the collateral has been acquired and liquidated or other arrangements can be made. The foreclosure process is lengthy (generally a minimum of six months and often much longer), so loans may be on nonaccrual status for a significant time period prior to moving to other real estate owned and sold. As soon as the amount of impairment is estimable, the amount of principal impairment is generally charged against the allowance for loan losses. However, until losses and selling costs can be estimated via appraisal or other means, a portion of the allowance may be allocated to specific impaired loans. The timing of the appraisal varies from loan to loan depending on the Bank’s ability to access the property. As of September 30, 2010 the allowance for loan losses included approximately $402,913 of reserves specifically related to impaired loans.

Management’s estimates of net realizable value or fair value of real estate collateral are obtained (on a nonrecurring basis) using independent appraisals, less estimated selling costs. Estimates of net realizable value for equipment and other types of personal property collateral are estimated based on input from equipment dealers and other professionals. If an appraisal is not available or management determines that fair value of the collateral is further impaired below the appraised value and there is not observable market price, the Company records the impaired loan as determined by Level 3 inputs as defined by FASB ASC 820, “Fair Value Measurements and Disclosures”.

Management identifies and maintains a list of potential problem loans. These are loans that are not included in nonaccrual status or impaired loans. A loan is added to the potential problem list when management becomes aware of information about possible credit problems of borrowers that causes serious doubts as to the ability of such borrowers to comply with the current loan repayment terms. These loans are designated as such in order to be monitored more closely than other credits in the Bank’s portfolio. There were loans in the amount of $2.9 million that have been determined by management to be potential problem loans at September 30, 2010. These loans are generally secured by real estate, and in many cases have been reappraised. Should potential problem loans become impaired, management will charge-off any impairment amount as soon as the amount of impairment can be determined.

Other real estate owned

As of September 30, 2010 the Company held other real estate owned as a result of foreclosures totaling $8.3 million representing 43 properties. Of the total recorded amount, $1.8 million relates to 6 commercial properties or commercial lots. The remainder represents 37 residential properties or lots. If, at the time of foreclosure, the fair value is determined to be lower than the Company’s recorded investment, a charge-off is recorded at that time. If an appraisal is available, the appraisal will be used to estimate fair value. If an appraisal is not available or management determines that fair value of the collateral is further impaired below the appraised value and there is not an observable market price, the Company records the impaired loan as determined by Level 3 inputs as defined by FASB ASC 820. If the property has been held for longer than one year, the Company’s policy is to arrange for an updated appraisal, unless the circumstances of the property indicate that an appraisal is not necessary. If a property is determined to be over-valued upon appraisal, the excess is charged to expense. At September 30, 2010, approximately $500,000 of other real estate was under contract for sale.

Other assets

As of September 30, 2010 other assets included accrued interest receivable on loans and investment securities available for sale totaling over $621,900, deferred tax assets of approximately $997,600, prepaid expenses of approximately $933,300 and several miscellaneous items. Prepaid expenses include $735,000 of FDIC premiums for 2010 through 2012 that were required to be prepaid to the FDIC in December 2009. See Note 6 to the unaudited consolidated financial statements above for additional information related to income taxes.

Deposits

The following table shows the average balance amounts and the average rates we paid on deposits for the nine months ended September 30, 2010 and 2009.

	Average Deposits
	Nine months ended September 30, 2010					Nine months ended September 30, 2009
	Amount		Rate			Amount		Rate


Noninterest bearing demand	$	11,609,719		-	%	$	10,897,772		-	%
Interest bearing transaction accounts		12,885,171		.46	%		13,116,268		.60	%
Savings and money market		50,233,872		1.57	%		30,792,513		1.89	%
Time deposits		77,324,499		2.04	%		87,898,317		2.63	%
Total average deposits	$	152,053,261				$	142,704,870

Included in total deposits as of September 30, 2010 were $26.4 million of deposits considered to be brokered deposits based on regulatory definitions. These deposits come from a variety of sources, and are generally fully insured by FDIC. The Company uses brokered deposits to fund various maturities that may not be attractive to customers in the local market area or to supplement local time deposits when interest rates offered locally are higher than interest rates on similar products in other markets. Pursuant to a formal agreement the Bank entered into with the Office of the Comptroller of the Currency (“OCC”) on May 12, 2010, we are currently required to obtain a determination of no supervisory objection from the OCC prior to accepting or renewing brokered deposits.

Borrowings

The Bank’s outstanding borrowings are described in the following table. The amounts listed as broker repurchase agreements are collateralized borrowings from other institutions. Retail repurchase agreements with the Bank’s customers are not included in the table below.

Borrowings at or for the nine months ended September, 2010

	Ending Balance		Period- End Rate			Maximum Month-end Balance		Average Balance		Weighted Average Rate Paid
Federal Home Loan Bank advances	$	6,630,047		2.41	%	$	9,730,602	$	8,511,470		2.52	%
Broker repurchase agreements	$	5,000,000		3.48	%	$	5,000,000	$	5,000,000		3.55	%

Of the $6.6 million of FHLB advances outstanding, $4.0 million mature in January, 2011, and $630,047 are principal reducing credits with final maturities in 2013 through 2015. The final $2.0 million is a convertible advance with a final maturity in 2018.

Of the $5.0 million of broker repurchase agreements outstanding, $2.0 million has a final maturity in January, 2013 and $3.0 million has a final maturity in January, 2015. Both are callable, quarterly, beginning on January 10, 2010 and January 15, 2012, respectively.

Estimated Fair Value of Financial Instruments

The estimated fair values of the Company's financial instruments were as follows:

		September 30, 2010				December 31, 2009
		Carrying		Fair		Carrying		Fair
		Amount		Value		Amount		Value
Financial Assets
Cash and due from banks	$	9,847,163	$	9,847,163	$	4,369,596	$	4,369,596
Federal funds sold		5,120,000		5,120,000		1,670,000		1,670,000
Investment securities		26,521,343		26,521,343		30,044,193		30,044,193
Loans, gross		124,822,848		126,210,319		137,763,251		139,365,487
Cash surrender value of life insurance policies		1,891,312		1,891,312		1,838,663		1,838,663
Financial Liabilities
Deposits		147,480,372		148,260,504		152,381,274		150,540,716
Customer repurchase agreements		2,779,057		2,850,558		3,257,002		3,354,199
Borrowings from FHLB		6,630,047		6,832,307		9,743,172		9,925,595
Broker repurchase agreements		5,000,000		5,128,743		5,000,000		5,182,105

The Company adopted a new accounting standard on January 1, 2008 which requires disclosure of the levels of inputs used in determining fair value of the Company’s assets measured at fair value, including available for sale securities and other real estate owned. The table below presents the balances of assets measured at fair value on a recurring or nonrecurring basis by level within the hierarchy of inputs that may be used to measure fair value.

	September 30, 2010
	Total		Level 1		Level 2		Level 3
Investment securities, recurring	$	26,521,343	$	18,972,270	$	6,459,923	$	1,089,150
Other real estate owned, nonrecurring	$	8,340,361	$	-	$	-	$	8,340,361
Impaired loans, nonrecurring	$	9,791,404	$	-	$	-	$	9,791,404
	September 30, 2009
	Total		Level 1		Level 2		Level 3
Investment securities, recurring	$	25,638,960	$	17,693,780	$	6,803,130	$	1,142,050
Other real estate owned, nonrecurring	$	4,848,984	$	-	$	-	$	4,848,984
Impaired loans, nonrecurring	$	16,529,460	$	-	$	-	$	16,529,460

Liquidity

Liquidity is the ability to meet current and future obligations through liquidation or maturity of existing assets or the acquisition of liabilities. The Company manages both assets and liabilities to achieve appropriate levels of liquidity. Cash and short-term investments are the Company’s primary sources of asset liquidity. These funds provide a cushion against short-term fluctuations in cash flow from both deposits and loans. The investment portfolio is the Company’s principal source of secondary asset liquidity. However, the availability of this source of funds is influenced by market conditions. Individual and commercial deposits and borrowings are the Company’s primary source of funding for credit activities. The Company has a line of credit with the FHLB of Atlanta. The FHLB line is based on the availability of eligible collateral, with a maximum borrowing capacity of 10% of Bank assets. The Bank currently has $6.6 million borrowed under the FHLB line. Approximately $11.5 million is available under the FHLB line, assuming adequate collateral is available for pledging. Management believes that the Company’s liquidity sources are adequate to meet its operating needs.

Off Balance Sheet Risk

Through the operations of the Bank, the Company has contractual commitments to extend credit in the ordinary course of its business activities. These commitments are legally binding agreements to lend money to the Bank’s customers at predetermined interest rates for a specified period of time. Commitments are subject to various conditions which are expected to reduce the credit risk to the Company. The Bank’s management evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by management upon extension of credit, is based on a credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial or residential real estate. Management manages the credit risk on these commitments by subjecting them to normal underwriting and risk management processes.

At September 30, 2010, the Bank had issued commitments to extend credit of $13.6 million through various types of lending arrangements and overdraft protection arrangements. Of that amount, approximately $7.0 million was undisbursed amounts of closed-end loans, $1.1 million was related to unused overdraft protection, and approximately $5.5 million was related to lines of credit. The Bank also had standby letters of credit outstanding of approximately $726,000 at September 30, 2010. An immaterial amount of fees were collected related to these commitments and letters of credit during the three-month period ended September 30, 2010. Historically many of these commitments and letters of credit expire unused, and the total amount committed as of September 30, 2010 is not necessarily expected to be funded.

The Bank offers an automatic overdraft protection product to checking account customers. Each qualified account with the automatic overdraft protection feature can have up to $500 of paid overdrafts. Unused overdraft protection was $1.1 million as of September 30, 2010, the majority of which is not expected to be utilized. As of September 30, 2010, accounts in overdraft status totaled $20,118.

Capital Resources

The capital base for the Company increased by $941,963 for the first nine months of 2010. This was due to sale of preferred stock, stock based compensation activity, and increases in accumulated other comprehensive income, partially offset by net losses. Stock based compensation activity includes the impact of accounting requirements on unexercised options. The Company’s ending equity to asset ratio was 10.45% as of September 30, 2010.

The following table details return on average assets (net income divided by average total assets, annualized in 2010), return on average equity (net income divided by average total equity, annualized in 2010), the ratio of average equity to average assets and the Dividend Payout Ratio (dividends paid divided by net income) as of and for the nine months ended September 30, 2010 and as of and for the year ended December 31, 2009. The annualized return on assets and return on equity for the first nine months of 2010 have improved compared to return on assets and return on equity for the year ended December 31, 2009. However, annualized results for the first nine months of 2010 may not be indicative of actual annual results for 2010.

	Nine- month period ended September 30, 2010			Year ended December 31, 2009
	(annualized)
Return on average assets		(.36	%)		(.75	%)
Return on average equity		(3.73	%)		(7.21	%)
Ratio of average equity to average assets		9.78	%		10.42	%
Dividend payout ratio		-	%		-	%

The FDIC has established guidelines for capital requirements for banks. As of September 30, 2010, the Bank is considered well capitalized based on the capital levels that are required to be maintained according to FDIC guidelines as shown in the following table.

Capital Ratios	Actual					Well Capitalized Requirement					Adequately Capitalized Requirement
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of September 30, 2010:	(Dollars in thousands)
Total capital to risk weighted assets	$	19,168		13.4	%	$	14,271		10.0	%	$	11,417		8.0	%
Tier 1 capital to risk weighted assets	$	17,370		12.2	%	$	8,563		6.0	%	$	5,709		4.0	%
Tier 1 capital to average assets	$	17,370		9.5	%	$	9,187		5.0	%	$	7,350		4.0	%

As of December 31, 2009:
Total capital to risk weighted assets	$	19,730		12.8	%	$	15,458		10.0	%	$	12,366		8.0	%
Tier 1 capital to risk weighted assets	$	17,788		11.5	%	$	9,274		6.0	%	$	6,183		4.0	%
Tier 1 capital to average assets	$	17,788		9.2	%	$	9,627		5.0	%	$	7,702		4.0	%

In addition to the FDIC requirements shown above, the Bank is currently required to maintain individual minimum capital ratios by the OCC. Those required ratios are: Total capital to risk weighted assets- 12.0%; Tier 1 capital to risk weighted assets – 11.0%; and Tier 1 capital to average assets- 9.0%.

The Federal Reserve has also established guidelines for capital requirements for bank holding companies that are similar to the FDIC’s guidelines for banks. At September 30, 2010 the Company exceeded all of the minimum requirements of the Federal Reserve guidelines.

Regulatory Actions

The Company has entered into a memorandum of understanding with the Federal Reserve Bank of Richmond (“FRB”). The memorandum of understanding requires the Company to seek permission from the FRB before it takes certain actions such as payment of cash dividends, redemption of outstanding stock, etc. The Company believes it is in compliance with the memorandum of understanding with the FRB as of September 30, 2010.

On May 12, 2010, the Bank entered into a formal agreement with the OCC requiring the Bank to take specified actions with respect to the operation of the Bank. The substantive actions called for by the agreement should strengthen the Bank and make it more efficient in the long-term.

Impact of Inflation

Unlike most industrial companies, the assets and liabilities of financial institutions such as the Company are primarily monetary in nature. Therefore, interest rates have a more significant impact on the Company’s performance than do the effects of changes in the general rate of inflation and changes in prices. In addition, interest rates do not necessarily move in the same magnitude as the prices of goods and services. As discussed previously, management seeks to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the risk of loss from adverse changes in market prices and rates which principally arises from liquidity risk and interest rate risk inherent in the Bank’s lending, deposit gathering, and borrowing activities. Other types of market risks such as foreign currency exchange risk and commodity price risk do not normally arise in the ordinary course of our business. The Funds Management Committee of our Board of Directors, which meets quarterly, monitors and considers methods of managing exposure to liquidity and interest rate risk. Management monitors liquidity and interest rate risk on an on-going basis. Management is responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities and managing our liquidity within board-approved limits.

Interest rate sensitivity “GAP” analysis measures the timing and magnitude of the repricing of assets compared with the repricing of liabilities and is an important part of asset/liability management. The objective of interest rate sensitivity management is to generate stable growth in net interest income, and to control the risks associated with interest rate movements. Management constantly reviews interest rate risk exposure and the expected interest rate environment so that adjustments in interest rate sensitivity can be made in a timely manner.

ITEM 4T. 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 period covered by this report, were effective.

There has been no change in the Company’s internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II - Other Information

ITEM 6. Exhibits

Exhibits:


31-1	Rule 13a-14(a)/ 15d-14(a) Certifications of Chief Executive Officer
31-2	Rule 13a-14(a)/Rule 15d-14(a) Certifications of Chief Financial Officer
32	18 U.S.C. Section 1350 Certifications

SIGNATURES

Pursuant to the requirements 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

(Registrant)

By: s/J. Rodger Anthony Date: November 12, 2010

J. Rodger Anthony

Chief Executive Officer

By: s/Jennifer M. Champagne Date: November 12, 2010

Jennifer M. Champagne

Senior Vice President and Chief Financial Officer

(Principal Financial Officer)

Attached files

CORNERSTONE BANCORP/SC Reports

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