##### Table of Contents

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United States

Securities and Exchange Commission

Washington, D.C. 20549



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FORM 10-QSB



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended June 30, 2005



| ̈ | 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: 0-25465



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CORNERSTONE BANCORP, INC./CT

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



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Connecticut                                                    |  | 06-1524044                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



550 Summer St.,
Stamford, Connecticut 06901

(Address of principal executive offices)



(203) 356-0111

(Issuers telephone number)



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Check whether the issuer (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days.    Yes  x    No ̈



The number of shares outstanding of the issuers common stock as of July 29, 2005 was
1,333,871.



Transitional Small Business Disclosure Format (check
one):    Yes ̈No  x



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##### Table of Contents

TABLE OF CONTENTS



PART I  Financial Information



|                                                                                                    |  |        |  | 
|--------------------------------------------------------------------------------------------------- |  | ------ |  | 
|                                                                                                    |  | PAGE  
|Item 1. Financial Statements                                                                        |  |       
|                                                                                                    | 
|Consolidated Statements of Condition June 30, 2005 (unaudited) and December 31, 2004                |  | 1     
|                                                                                                    | 
|Consolidated Statements of Income Three Months Ended June 30, 2005 and 2004 (unaudited)             |  | 2     
|                                                                                                    | 
|Consolidated Statements of Income Six Months Ended June 30, 2005 and 2004 (unaudited)               |  | 3     
|                                                                                                    | 
|Consolidated Statements of Stockholders Equity Six Months Ended June 30, 2005 and 2004 (unaudited) |  | 4     
|                                                                                                    | 
|Consolidated Statements of Cash Flows Six Months Ended June 30, 2005 and 2004 (unaudited)           |  | 5     
|                                                                                                    | 
|Notes to Consolidated Financial Statements (unaudited)                                              |  | 6 - 9 
|                                                                                                    | 
|Item 2. Managements Discussion and Analysis or Plan of Operation                                   |  | 9 - 21
|                                                                                                    | 
|Item 3. Controls and Procedures                                                                     |  | 21    
|                                                                                                    | 
|PART II  Other Information                                                                         |  |       
|                                                                                                    | 
|Item 1. Legal Proceedings                                                                           |  | None  
|                                                                                                    | 
|Item 2. Changes in Securities and Use of Proceeds                                                   |  | None  
|                                                                                                    | 
|Item 3. Defaults upon Senior Securities                                                             |  | None  
|                                                                                                    | 
|Item 4. Submission of Matters to a Vote of Security Holders                                         |  | None  
|                                                                                                    | 
|Item 5. Other Information                                                                           |  | None  
|                                                                                                    | 
|Item 6. Exhibits                                                                                    |  | 22    
|                                                                                                    | 
|Signatures                                                                                          |  | 23    



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##### Table of Contents

PART 1 - Financial Information



Item 1. Financial Statements.



CORNERSTONE BANCORP, INC. AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF CONDITION



(In
thousands, except per share data)



|                                                                                                                                                                                                      |  |              |         |   |                   |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                                                                      |  | June 30,2005 |         |   | December 31, 2004 |  
|                                                                                                                                                                                                      |  | (unaudited)  |         |   |                   |  
|Assets                                                                                                                                                                                                |  |              |         |   |                   |   |         |  
|Cash and cash equivalents:                                                                                                                                                                            |  |              |         |   |                   |   |         |  
|Cash and due from banks                                                                                                                                                                               |  | $            | 8,617   |   |                   | $ | 8,205   |  
|Federal funds sold                                                                                                                                                                                    |  |              | 29,500  |   |                   |   | 9,200   |  
|                                                                                                                                                                                                      |  |              |         |   |                   |   |         |  
|Total cash and cash equivalents                                                                                                                                                                       |  |              | 38,117  |   |                   |   | 17,405  |  
|                                                                                                                                                                                                      |  |              |         |   |                   |   |         |  
|Securities, including collateral of $8,832 in 2005 and $6,459 in 2004 for borrowings under securities repurchase agreements:                                                                          |  |              |         |   |                   |   |         |  
|Available for sale, at fair value                                                                                                                                                                     |  |              | 1,794   |   |                   |   | 2,962   |  
|Held to maturity, at amortized cost (fair value of $43,082 in 2005 and $52,298 in 2004)                                                                                                               |  |              | 43,394  |   |                   |   | 47,872  |  
|                                                                                                                                                                                                      |  |              |         |   |                   |   |         |  
|Total securities                                                                                                                                                                                      |  |              | 45,188  |   |                   |   | 50,834  |  
|                                                                                                                                                                                                      |  |              |         |   |                   |   |         |  
|Loans held for sale                                                                                                                                                                                   |  |              | 1,758   |   |                   |   | 1,994   |  
|Loans, net of allowance for loan losses of $2,268 at June 30, 2005 and $2,216 at December 31, 2004                                                                                                    |  |              | 134,383 |   |                   |   | 130,617 |  
|Accrued interest receivable                                                                                                                                                                           |  |              | 1,012   |   |                   |   | 996     |  
|Federal Home Loan Bank stock, at cost                                                                                                                                                                 |  |              | 667     |   |                   |   | 613     |  
|Premises and equipment                                                                                                                                                                                |  |              | 3,025   |   |                   |   | 3,207   |  
|Bank-owned life insurance                                                                                                                                                                             |  |              | 4,969   |   |                   |   | 4,858   |  
|Deferred income taxes                                                                                                                                                                                 |  |              | 949     |   |                   |   | 990     |  
|Other assets                                                                                                                                                                                          |  |              | 813     |   |                   |   | 288     |  
|                                                                                                                                                                                                      |  |              |         |   |                   |   |         |  
|Total assets                                                                                                                                                                                          |  | $            | 230,881 |   |                   | $ | 211,802 |  
|                                                                                                                                                                                                      |  |              |         |   |                   |   |         |  
|Liabilities and Stockholders Equity                                                                                                                                                                  |  |              |         |   |                   |   |         |  
|Liabilities:                                                                                                                                                                                          |  |              |         |   |                   |   |         |  
|Deposits:                                                                                                                                                                                             |  |              |         |   |                   |   |         |  
|Demand (non-interest bearing)                                                                                                                                                                         |  | $            | 50,773  |   |                   | $ | 42,225  |  
|Money market demand and NOW                                                                                                                                                                           |  |              | 44,905  |   |                   |   | 39,561  |  
|Regular, club and preferred rate savings                                                                                                                                                              |  |              | 36,500  |   |                   |   | 42,202  |  
|Time                                                                                                                                                                                                  |  |              | 63,272  |   |                   |   | 53,139  |  
|                                                                                                                                                                                                      |  |              |         |   |                   |   |         |  
|Total deposits                                                                                                                                                                                        |  |              | 195,450 |   |                   |   | 177,127 |  
|                                                                                                                                                                                                      |  |             
|Borrowings under securities repurchase agreements                                                                                                                                                     |  |              | 8,850   |   |                   |   | 10,060  |  
|Accrued interest payable                                                                                                                                                                              |  |              | 92      |   |                   |   | 75      |  
|Other liabilities                                                                                                                                                                                     |  |              | 2,710   |   |                   |   | 1,908   |  
|                                                                                                                                                                                                      |  |              |         |   |                   |   |         |  
|Total liabilities                                                                                                                                                                                     |  |              | 207,102 |   |                   |   | 189,170 |  
|                                                                                                                                                                                                      |  |              |         |   |                   |   |         |  
|Stockholders equity                                                                                                                                                                                  |  |              |         |   |                   |   |         |  
|Common stock, par value $0.01 per share. Authorized 5,000,000 shares; issued 1,335,734 shares in 2005 and 1,301,348 shares in 2004;
outstanding 1,294,348 shares in 2005 and 1,259,962 shares in 2004 |  |              | 13      |   |                   |   | 13      |  
|Additional paid-in capital                                                                                                                                                                            |  |              | 15,325  |   |                   |   | 14,673  |  
|Retained earnings                                                                                                                                                                                     |  |              | 9,503   |   |                   |   | 9,117   |  
|Treasury stock, at cost (41,386 shares in 2005 and 41,386 shares in 2004)                                                                                                                             |  |              | (433    | ) |                   |   | (433    | )
|Unearned restricted stock awards                                                                                                                                                                      |  |              | (622    | ) |                   |   | (728    | )
|Accumulated other comprehensive loss, net of taxes                                                                                                                                                    |  |              | (7      | ) |                   |   | (10     | )
|                                                                                                                                                                                                      |  |              |         |   |                   |   |         |  
|Total stockholders equity                                                                                                                                                                            |  |              | 23,779  |   |                   |   | 22,632  |  
|                                                                                                                                                                                                      |  |              |         |   |                   |   |         |  
|Total liabilities and stockholders equity                                                                                                                                                            |  | $            | 230,881 |   |                   | $ | 211,802 |  
|                                                                                                                                                                                                      |  |              |         |   |                   |   |         |  



See accompanying notes to consolidated
financial statements.



1



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##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED JUNE 30, 2005 AND 2004

(In thousands, except per share data)

(unaudited)



|                                                                  |  |                             |           |      |   |           |  
|----------------------------------------------------------------- |  | --------------------------- | --------- | ---- | - | --------- | -
|                                                                  |  | Three Months Ended June 30, |          
|                                                                  |  | 2005                        |           | 2004 |  
|Interest income:                                                  |  |                             |           |      |   |           |  
|Loans                                                             |  | $                           | 2,566     |      | $ | 2,218     |  
|Securities                                                        |  |                             | 385       |      |   | 375       |  
|Federal funds sold                                                |  |                             | 79        |      |   | 69        |  
|                                                                  |  |                             |           |      |   |           |  
|Total interest income                                             |  |                             | 3,030     |      |   | 2,662     |  
|                                                                  |  |                             |           |      |   |           |  
|Interest expense:                                                 |  |                             |           |      |   |           |  
|Deposits                                                          |  |                             | 609       |      |   | 558       |  
|Borrowings                                                        |  |                             | 44        |      |   | 18        |  
|                                                                  |  |                             |           |      |   |           |  
|Total interest expense                                            |  |                             | 653       |      |   | 576       |  
|                                                                  |  |                             |           |      |   |           |  
|Net interest income                                               |  |                             | 2,377     |      |   | 2,086     |  
|Provision for (recovery of) loan losses                           |  |                             | 48        |      |   | (39       | )
|                                                                  |  |                             |           |      |   |           |  
|Net interest income after provision for (recovery of) loan losses |  |                             | 2,329     |      |   | 2,125     |  
|                                                                  |  |                             |           |      |   |           |  
|Non-interest income:                                              |  |                             |           |      |   |           |  
|Gain on sale of loans and loan servicing, net                     |  |                             | 164       |      |   | 90        |  
|Deposit service charges                                           |  |                             | 98        |      |   | 128       |  
|Bank-owned life insurance                                         |  |                             | 45        |      |   | 48        |  
|Other                                                             |  |                             | 245       |      |   | 211       |  
|                                                                  |  |                             |           |      |   |           |  
|Total non-interest income                                         |  |                             | 552       |      |   | 477       |  
|                                                                  |  |                             |           |      |   |           |  
|Non-interest expense:                                             |  |                             |           |      |   |           |  
|Salaries and employee benefits                                    |  |                             | 1,189     |      |   | 1,093     |  
|Occupancy                                                         |  |                             | 234       |      |   | 177       |  
|Furniture and equipment                                           |  |                             | 107       |      |   | 114       |  
|Data processing                                                   |  |                             | 127       |      |   | 119       |  
|Professional fees                                                 |  |                             | 293       |      |   | 94        |  
|Advertising and promotion                                         |  |                             | 41        |      |   | 42        |  
|Other                                                             |  |                             | 288       |      |   | 281       |  
|                                                                  |  |                             |           |      |   |           |  
|Total non-interest expense                                        |  |                             | 2,279     |      |   | 1,920     |  
|                                                                  |  |                             |           |      |   |           |  
|Income before income tax expense                                  |  |                             | 602       |      |   | 682       |  
|Income tax expense                                                |  |                             | 299       |      |   | 260       |  
|                                                                  |  |                             |           |      |   |           |  
|Net income                                                        |  | $                           | 303       |      | $ | 422       |  
|                                                                  |  |                             |           |      |   |           |  
|Earnings per common share (Note B):                               |  |                             |           |      |   |           |  
|Basic                                                             |  | $                           | 0.24      |      | $ | 0.35      |  
|Diluted                                                           |  |                             | 0.23      |      |   | 0.33      |  
|                                                                  |  |                             |           |      |   |           |  
|Weighted average common shares (Note B):                          |  |                             |           |      |   |           |  
|Basic                                                             |  |                             | 1,244,859 |      |   | 1,208,597 |  
|Diluted                                                           |  |                             | 1,312,569 |      |   | 1,290,610 |  
|                                                                  |  |                             |           |      |   |           |  



See accompanying notes to consolidated
financial statements.



2



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##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF INCOME



FOR THE
SIX MONTHS ENDED JUNE 30, 2005 AND 2004



(In thousands,
except per share data)



(unaudited)



|                                                                  |  |                           |           |      |   |           |  
|----------------------------------------------------------------- |  | ------------------------- | --------- | ---- | - | --------- | -
|                                                                  |  | Six Months Ended June 30, |          
|                                                                  |  | 2005                      |           | 2004 |  
|Interest income:                                                  |  |                           |           |      |   |           |  
|Loans                                                             |  | $                         | 5,119     |      | $ | 4,556     |  
|Securities                                                        |  |                           | 796       |      |   | 693       |  
|Federal funds sold                                                |  |                           | 132       |      |   | 166       |  
|                                                                  |  |                           |           |      |   |           |  
|Total interest income                                             |  |                           | 6,047     |      |   | 5,415     |  
|                                                                  |  |                           |           |      |   |           |  
|Interest expense:                                                 |  |                           |           |      |   |           |  
|Deposits                                                          |  |                           | 1,141     |      |   | 1,191     |  
|Borrowings                                                        |  |                           | 109       |      |   | 32        |  
|                                                                  |  |                           |           |      |   |           |  
|Total interest expense                                            |  |                           | 1,250     |      |   | 1,223     |  
|                                                                  |  |                           |           |      |   |           |  
|Net interest income                                               |  |                           | 4,797     |      |   | 4,192     |  
|                                                                  |  |                          
|Provision for (recovery of) loan losses                           |  |                           | 102       |      |   | (550      | )
|                                                                  |  |                           |           |      |   |           |  
|Net interest income after provision for (recovery of) loan losses |  |                           | 4,695     |      |   | 4,742     |  
|                                                                  |  |                           |           |      |   |           |  
|Non-interest income:                                              |  |                           |           |      |   |           |  
|Gain on sale of loans and loan servicing, net                     |  |                           | 171       |      |   | 289       |  
|Deposit service charges                                           |  |                           | 201       |      |   | 227       |  
|Bank-owned life insurance                                         |  |                           | 86        |      |   | 88        |  
|Other                                                             |  |                           | 404       |      |   | 855       |  
|                                                                  |  |                           |           |      |   |           |  
|Total non-interest income                                         |  |                           | 862       |      |   | 1,459     |  
|                                                                  |  |                           |           |      |   |           |  
|Non-interest expense:                                             |  |                           |           |      |   |           |  
|Salaries and employee benefits                                    |  |                           | 2,386     |      |   | 2,443     |  
|Occupancy                                                         |  |                           | 436       |      |   | 366       |  
|Furniture and equipment                                           |  |                           | 218       |      |   | 228       |  
|Data processing                                                   |  |                           | 256       |      |   | 252       |  
|Professional fees                                                 |  |                           | 418       |      |   | 188       |  
|Advertising and promotion                                         |  |                           | 90        |      |   | 86        |  
|Other                                                             |  |                           | 537       |      |   | 521       |  
|                                                                  |  |                           |           |      |   |           |  
|Total non-interest expense                                        |  |                           | 4,341     |      |   | 4,084     |  
|                                                                  |  |                           |           |      |   |           |  
|Income before income tax expense                                  |  |                           | 1,216     |      |   | 2,117     |  
|                                                                  |  |                          
|Income tax expense                                                |  |                           | 541       |      |   | 640       |  
|                                                                  |  |                           |           |      |   |           |  
|Net income                                                        |  | $                         | 675       |      | $ | 1,477     |  
|                                                                  |  |                           |           |      |   |           |  
|Earnings per common share (Note B):                               |  |                           |           |      |   |           |  
|Basic                                                             |  | $                         | 0.55      |      | $ | 1.22      |  
|Diluted                                                           |  |                           | 0.51      |      |   | 1.15      |  
|                                                                  |  |                           |           |      |   |           |  
|Weighted average common shares (Note B):                          |  |                           |           |      |   |           |  
|Basic                                                             |  |                           | 1,236,608 |      |   | 1,207,723 |  
|Diluted                                                           |  |                           | 1,312,262 |      |   | 1,283,797 |  
|                                                                  |  |                           |           |      |   |           |  



See accompanying notes to consolidated
financial statements.



3



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##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY



FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004



(In thousands, except per share data)



(undaudited)



|                                           |  |             |    |                            |   |                   |  |   |                |   |  |                                  |      |   |                                               |   |      |                            |  |   |     |   |  |   |        |  
|------------------------------------------ |  | ----------- | -- | -------------------------- | - | ----------------- |  | - | -------------- | - |  | -------------------------------- | ---- | - | --------------------------------------------- | - | ---- | -------------------------- |  | - | --- | - |  | - | ------ | -
|                                           |  | CommonStock |    | Additional Paid-in Capital |   | Retained Earnings |  |   | Treasury Stock |   |  | Unearned Restricted Stock Awards |      |   | Accumulated Other Comprehensive Income (Loss) |   |      | Total Stockholders Equity | 
|Balances at January 1, 2004                |  | $           | 13 |                            | $ | 14,298            |  | $ | 7,253          |   |  | $                                | (545 | ) |                                               | $ | (558 | )                          |  | $ | 26  |   |  | $ | 20,487 |  
|                                           |  |             |    |                            |   |                   | 
|Comprehensive income:                      |  |             |    |                            |   |                   |  |   |                |   |  |                                  |      |   |                                               |   |      |                            |  |   |     |   |  |   |        |  
|Net income                                 |  |             |   |                            |   |                  |  |   | 1,477          |   |  |                                  |     |   |                                               |   |     |                            |  |   |    |   |  |   | 1,477  |  
|Other comprehensive income (note D)        |  |             |   |                            |   |                  |  |   |               |   |  |                                  |     |   |                                               |   |     |                            |  |   | (32 | ) |  |   | (32    | )
|                                           |  |             |    |                            |   |                   | 
|Total comprehensive income                 |  |             |    |                            |   |                   |  |   |                |   |  |                                  |      |   |                                               |   |      |                            |  |   |     |   |  |   | 1,445  |  
|                                           |  |             |    |                            |   |                   | 
|Cash dividends declared ($0.225 per share) |  |             |   |                            |   |                  |  |   | (281           | ) |  |                                  |     |   |                                               |   |     |                            |  |   |    |   |  |   | (281   | )
|                                           |  |             |    |                            |   |                   | 
|Shares issued in connection with:          |  |             |    |                            |   |                   |  |   |                |   |  |                                  |      |   |                                               |   |      |                            |  |   |     |   |  |   |        |  
|Restricted stock awards                    |  |             |   |                            |   | 75                |  |   |               |   |  |                                  | 80   |   |                                               |   | (155 | )                          |  |   |    |   |  |   |       |  
|Stock Option Exercises                     |  |             |    |                            |   | 20                |  |   |               |   |  |                                  |     |   |                                               |   |     |                            |  |   |    |   |  |   | 20     |  
|Dividend Reinvestment Plan                 |  |             |   |                            |   | 55                |  |   |               |   |  |                                  |     |   |                                               |   |     |                            |  |   |    |   |  |   | 55     |  
|                                           |  |             |    |                            |   |                   |  |   |                |   |  |                                  |      |   |                                               |   |      |                            |  |   |     |   |  |   |        |  
|Balances at June 30, 2004                  |  |             | 13 |                            |   | 14,448            |  |   | 8,449          |   |  |                                  | (465 | ) |                                               |   | (713 | )                          |  |   | (6  | ) |  |   | 21,726 |  
|                                           |  |             |    |                            |   |                   |  |   |                |   |  |                                  |      |   |                                               |   |      |                            |  |   |     |   |  |   |        |  
|Balances at January 1, 2005                |  | $           | 13 |                            | $ | 14,673            |  | $ | 9,117          |   |  | $                                | (433 | ) |                                               | $ | (728 | )                          |  | $ | (10 | ) |  | $ | 22,632 |  
|Comprehensive income:                      |  |             |    |                            |   |                   |  |   |                |   |  |                                  |      |   |                                               |   |      |                            |  |   |     |   |  |   |        |  
|Net income                                 |  |             |   |                            |   |                   |  |   | 675            |   |  |                                  |     |   |                                               |   |     |                            |  |   |    |   |  |   | 675    |  
|Other comprehensive income (note D)        |  |             |   |                            |   |                  |  |   |               |   |  |                                  |     |   |                                               |   |     |                            |  |   | 3   |   |  |   | 3      |  
|Total comprehensive income                 |  |             |    |                            |   |                   |  |   |                |   |  |                                  |      |   |                                               |   |      |                            |  |   |     |   |  |   | 678    |  
|Cash dividends declared ($0.225 per share) |  |             |   |                            |   |                  |  |   | (289           | ) |  |                                  |     |   |                                               |   |     |                            |  |   |    |   |  |   | (289   | )
|Shares issued in connection with:          |  |             |    |                            |   |                   |  |   |                |   |  |                                  |      |   |                                               |   |      |                            |  |   |     |   |  |   |        |  
|Restricted stock awards                    |  |             |   |                            |   | 46                |  |   |               |   |  |                                  |     |   |                                               |   | 106  |                            |  |   |    |   |  |   | 152    |  
|Stock option exercises                     |  |             |   |                            |   | 542               |  |   |               |   |  |                                  |     |   |                                               |   |     |                            |  |   |    |   |  |   | 542    |  
|Dividend Reinvestment Plan                 |  |             |   |                            |   | 64                |  |   |               |   |  |                                  |     |   |                                               |   |     |                            |  |   |    |   |  |   | 64     |  
|                                           |  |             |    |                            |   |                   |  |   |                |   |  |                                  |      |   |                                               |   |      |                            |  |   |     |   |  |   |        |  
|Balances at June 30, 2005                  |  |             | 13 |                            |   | 15,325            |  |   | 9,503          |   |  |                                  | (433 | ) |                                               |   | (622 | )                          |  |   | (7  | ) |  |   | 23,779 |  
|                                           |  |             |    |                            |   |                   |  |   |                |   |  |                                  |      |   |                                               |   |      |                            |  |   |     |   |  |   |        |  



See accompanying notes to unaudited
consolidated financial statements.



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##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004

(In thousands)

(unaudited)



|                                                                                  |  |      |        |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------- | -
|                                                                                  |  | 2005 |        |   | 2004 |  
|Operating activities:                                                             |  |      |        |   |      |   |         |  
|Net income                                                                        |  | $    | 675    |   |      | $ | 1,477   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |        |   |      |   |         |  
|Depreciation and amortization                                                     |  |      | 196    |   |      |   | 270     |  
|Provision for (recovery of) loan losses                                           |  |      | 102    |   |      |   | (550    | )
|Originations of loans held for sale                                               |  |      | (4,952 | ) |      |   | (8,032  | )
|Proceeds from sales of loans held for sale                                        |  |      | 5,488  |   |      |   | 8,633   |  
|Increase in accrued interest receivable                                           |  |      | (16    | ) |      |   | (61     | )
|Increase in other assets                                                          |  |      | (525   | ) |      |   | (67     | )
|Increase (decrease) in accrued interest payable                                   |  |      | 17     |   |      |   | (31     | )
|Increase in other liabilities                                                     |  |      | 802    |   |      |   | 472     |  
|Income on bank-owned life insurance                                               |  |      | (86    | ) |      |   | (88     | )
|Other adjustments, net                                                            |  |      | 26     |   |      |   | (70     | )
|                                                                                  |  |      |        |   |      |   |         |  
|Net cash provided by operating activities                                         |  |      | 1,727  |   |      |   | 1,953   |  
|                                                                                  |  |      |        |   |      |   |         |  
|Investing activities:                                                             |  |      |        |   |      |   |         |  
|Proceeds from maturities and calls of securities available for sale               |  |      | 1,161  |   |      |   | 6,788   |  
|Proceeds from maturities and calls of securities held to maturity                 |  |      | 4,486  |   |      |   | 7,224   |  
|Purchases of securities available for sale                                        |  |      |       |   |      |   |        |  
|Purchases of securities held to maturity                                          |  |      |       |   |      |   | (36,152 | )
|Net loan originations, other than loans held for sale                             |  |      | (3,801 | ) |      |   | (9,131  | )
|(Purchases) redemption of bank-owned life insurance                               |  |      | (25    | ) |      |   | 666     |  
|Purchases of Federal Home Loan Bank stock                                         |  |      | (54    | ) |      |   |        |  
|Purchases of premises and equipment                                               |  |      | (12    | ) |      |   | (411    | )
|                                                                                  |  |      |        |   |      |   |         |  
|Net cash provided by (used in) investing activities                               |  |      | 1,755  |   |      |   | (31,016 | )
|                                                                                  |  |      |        |   |      |   |         |  
|Financing activities:                                                             |  |      |        |   |      |   |         |  
|Net increase (decrease) in deposits                                               |  |      | 18,323 |   |      |   | (2,337  | )
|Net (decrease) increase in borrowings under securities repurchase agreements      |  |      | (1,210 | ) |      |   | 1,881   |  
|Dividends paid on common stock                                                    |  |      | (285   | ) |      |   | (279    | )
|Proceeds from issuance of common stock                                            |  |      | 402    |   |      |   | 75      |  
|                                                                                  |  |      |        |   |      |   |         |  
|Net cash provided by (used in) financing activities                               |  |      | 17,230 |   |      |   | (660    | )
|                                                                                  |  |      |        |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                              |  |      | 20,712 |   |      |   | (29,723 | )
|                                                                                  |  |     
|Cash and cash equivalents at beginning of year                                    |  |      | 17,405 |   |      |   | 62,829  |  
|                                                                                  |  |      |        |   |      |   |         |  
|Cash and cash equivalents at end of year                                          |  | $    | 38,117 |   |      | $ | 33,106  |  
|                                                                                  |  |      |        |   |      |   |         |  
|Supplemental information:                                                         |  |      |        |   |      |   |         |  
|Interest payments                                                                 |  | $    | 1,233  |   |      | $ | 1,254   |  
|Income tax payments                                                               |  |      | 560    |   |      |   | 832     |  
|Increase in liability for securities purchased, not yet settled                   |  |      |       |   |      |   | 3,030   |  



See accompanying notes to consolidated
financial statements.



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##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (UNAUDITED)

(dollars in thousands)



NOTE A - BASIS OF FINANCIAL STATEMENT PRESENTATION



The accompanying unaudited interim consolidated financial statements include the accounts of Cornerstone Bancorp, Inc., its subsidiary Cornerstone Bank
(the Bank), and the Banks subsidiary Cornerstone Business Credit, Inc. (CBC), collectively the Company. The interim consolidated financial statements have been prepared in conformity with accounting
principles generally accepted in the United States of America for interim financial statements and the instructions to Form 10-QSB, and, accordingly, do not include all of the information and footnotes required by generally accepted accounting
principles for a complete set of financial statements. While management believes that the disclosures presented are adequate so as not to make the information misleading, it is suggested that these interim consolidated financial statements be read
in conjunction with the annual consolidated financial statements and notes included in the Form 10-KSB for the year ended December 31, 2004. The interim results of operations for the period ended June 30, 2005 are not necessarily indicative of the
results to be expected for the year ending December 31, 2005 or for any other interim period.



In the opinion of management, the accompanying unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring accruals, necessary to present fairly the financial position,
results of operations, changes in stockholders equity and cash flows at the dates and for the periods presented. In preparing the interim consolidated financial statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities as of the date of the statement of condition and revenues and expenses for the period. Actual results could differ significantly from those estimates as a result of changing conditions and future
events. An estimate that is particularly critical and susceptible to significant near-term change is the allowance for loan losses.



Prior period amounts are reclassified, whenever necessary, to conform to the current period presentation.



NOTE B - EARNINGS PER SHARE



Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding during the period. For this purpose, unvested shares of restricted stock are not considered to be outstanding. Diluted EPS is computed in a similar manner, except that the
weighted average number of common shares is increased (using the treasury stock method) by additional common shares that would have been outstanding if all potentially dilutive securities (such as stock options and unvested restricted stock awards)
were exercised or vested during the period. For the three-month and six month periods ended June 30, 2005 and 2004, the number of shares for diluted EPS exceeded the number of shares for basic EPS due to the dilutive effect of outstanding stock
options and unvested restricted stock. For purposes of computing basic and diluted EPS, net income applicable to common stock equaled net income for these periods.



NOTE C  STOCK-BASED COMPENSATION



The Company accounts for stock-based compensation in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations.



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##### Table of Contents

Accordingly, compensation expense is not recognized for fixed stock options if the exercise price of the option equals
the fair value of the underlying stock at the grant date. The fair value of restricted stock awards, measured at the grant date, is recognized as unearned compensation (a component of stockholders equity) and amortized to compensation expense
over the vesting period.



Statement of Financial Accounting Standards
(SFAS) No. 123, Accounting for Stock-Based Compensation, encourages the use of a fair-value-based method of accounting for employee stock compensation plans, but permits the continued use of the intrinsic-value-based method of
accounting prescribed by APB Opinion No. 25. Under SFAS No. 123, the grant-date fair value of options is recognized as compensation expense over the vesting period (if any). The Company has elected to continue to apply APB Opinion No. 25 and
disclose the pro forma information required by SFAS No. 123. Had stock-based compensation expense been recognized in accordance with SFAS No. 123, the Companys net income and earnings per common share would have been adjusted to the following
pro forma amounts:



|                                                                                                                          |  |                                      |      |   |                                      |   |      |      |  |   |      |   |  |   |       |  
|------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------ | ---- | - | ------------------------------------ | - | ---- | ---- |  | - | ---- | - |  | - | ----- | -
|                                                                                                                          |  | Three Months Ended June 30,          |      |   | Six Months Ended June 30,            |  
|                                                                                                                          |  | 2005                                 |      |   | 2004                                 |   |      | 2005 |  |   | 2004 |  
|                                                                                                                          |  | (in thousands except per share data) |      |   | (in thousands except per share data) |  
|Net income, as reported                                                                                                   |  | $                                    | 303  |   |                                      | $ | 422  |      |  | $ | 675  |   |  | $ | 1,477 |  
|Add restriced stock expense included in reported net income, net of related tax effects                                   |  |                                      | 20   |   |                                      |   | 24   |      |  |   | 44   |   |  |   | 50    |  
|                                                                                                                          |  |                                      |      |  
|Deduct restricted stock and stock option expense determined under the fair-value-based method, net of related tax effects |  |                                      | (20  | ) |                                      |   | (37  | )    |  |   | (44  | ) |  |   | (100  | )
|                                                                                                                          |  |                                      |      |   |                                      |   |      |      |  |   |      |   |  |   |       |  
|Pro forma net income                                                                                                      |  |                                      | 303  |   |                                      |   | 409  |      |  |   | 675  |   |  |   | 1,427 |  
|                                                                                                                          |  |                                      |      |   |                                      |   |      |      |  |   |      |   |  |   |       |  
|Basic earnings per common share:                                                                                          |  |                                      |      |   |                                      |   |      |      |  |   |      |   |  |   |       |  
|As reported                                                                                                               |  | $                                    | 0.24 |   |                                      | $ | 0.35 |      |  | $ | 0.55 |   |  | $ | 1.22  |  
|Pro forma                                                                                                                 |  |                                      | 0.24 |   |                                      |   | 0.34 |      |  |   | 0.55 |   |  |   | 1.18  |  
|                                                                                                                          |  |                                      |      |   |                                      |   |      |      |  |   |      |   |  |   |       |  
|Diluted earnings per common share:                                                                                        |  |                                      |      |   |                                      |   |      |      |  |   |      |   |  |   |       |  
|As reported                                                                                                               |  | $                                    | 0.23 |   |                                      | $ | 0.33 |      |  | $ | 0.51 |   |  | $ | 1.15  |  
|Pro forma                                                                                                                 |  |                                      | 0.23 |   |                                      |   | 0.32 |      |  |   | 0.51 |   |  |   | 1.11  |  
|                                                                                                                          |  |                                      |      |   |                                      |   |      |      |  |   |      |   |  |   |       |  



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##### Table of Contents

NOTE D  COMPREHENSIVE INCOME (LOSS)



Comprehensive income (loss) includes net income and any changes in stockholders equity from non-owner sources that are
not recognized in the income statement (such as changes in net unrealized gains and losses on securities available for sale). Other comprehensive income (loss) reported in the statements of stockholders equity for the six months ended June 30,
2005 and 2004 represents the change during those periods in the after-tax net unrealized gain (loss) on securities available for sale.



NOTE E  STANDBY LETTERS OF CREDIT



The Company had outstanding letters of credit of $1,230 at June 30, 2005 and $1,216 at December 31, 2004, respectively. Substantially all of the
Companys outstanding standby letters of credit are performance standby letters of credit within the scope of FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees
of Indebtedness of Others (FIN 45). These are irrevocable undertakings by the Company, as guarantor, to make payments in the event a specified third party fails to perform under a non-financial contractual obligation. Most of the
Companys performance standby letters of credit arise in connection with lending relationships and have terms of one year or less. The maximum potential future payments the Company could be required to make equals the contract amount of the
standby letters of credit referred to above. FIN 45 also requires the recognition, at fair value, of a liability by a guarantor at the inception of certain guarantees issued or modified after December 31, 2004. The Companys recognized
liability for performance standby letters of credit was insignificant at June 30, 2005.



NOTE F  RECENT ACCOUNTING STANDARDS



The
Financial Accounting Standards Board (FASB) issued a revision of SFAS No. 123, Share-Based Payment (SFAS 123R), in December 2004, which requires an entity to recognize the grant-date fair-value of stock options and other equity-based
compensation issued to employees in the income statement. SFAS 123R requires both public and non-public entities to disclose information needed about the nature of the share-based payment transactions and the effects of those transactions on the
financial statements. SFAS 123R generally requires that an entity account for those transactions using the fair-value based method and eliminates an entitys ability to account for share-based compensation using the intrinsic value method of
accounting in APB Opinion No. 25, which was permitted under SFAS No. 123, as originally issued. SFAS 123R is effective, for the Company, as of the beginning of the first interim or annual reporting period that begins after December 15, 2005.



In December 2003, the FASB issued Interpretation No. 46
(revised), Consolidation of Variable Interest Entities (FIN 46R), which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and,
accordingly, should consolidate the variable interest entity (VIE). FIN 46R replaces FASB Interpretation No. 46 that was issued in January 2003. As a public company that is a small business issuer, as defined in applicable Securities and
Exchange Commission (SEC) regulations, the Company was required to apply FIN 46R to VIEs no later than the end of the first reporting period ending after December 15, 2004. For any VIEs that must be consolidated under FIN 46R that were
created before January 1, 2004, the assets, liabilities and noncontrolling interest of the VIE initially would be measured at their carrying amounts, and any difference between the net amount added to the balance sheet and any previously recognized
interest would be recorded as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair



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##### Table of Contents

value at the date FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of the
VIE. The Company currently holds no interests in VIEs and, accordingly, FIN 46R currently does not have an effect on its consolidated financial statements.



NOTE G  MERGER



On April 12, 2005, Cornerstone Bancorp, Inc. entered into an Agreement and Plan of Merger dated as of April 12, 2005 (the Merger Agreement) by
and among CBI, NewAlliance Bancshares, Inc. (NAL) and their wholly-owned subsidiaries, Cornerstone Bank and NewAlliance Bank. Subject to the terms of the Merger Agreement, Cornerstone Bancorp, Inc., will merge with and into NAL (the
Merger) and immediately thereafter, Cornerstone Bank will merge with and into NewAlliance Bank.



Item 2. Managements Discussion and Analysis or Plan of Operation.

(dollars in thousands)



FORWARD-LOOKING STATEMENTS



The statements contained in this report that are not historical are
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Examples of such forward-looking statements include, without
limitation, statements regarding expectations for earnings, credit quality, and other financial and business matters. When used in this report, the words anticipate, plan, believe, estimate,
expect and similar expressions as they relate to the Company or its management are intended to identify forward-looking statements. All forward-looking statements involve risks and uncertainties. Actual results may differ materially from
those discussed in, or implied by, the forward-looking statements as a result of certain factors, including but not limited to, competitive pressures on loan and deposit product pricing; other actions of competitors; changes in economic conditions;
technological changes; the extent and timing of actions of the Federal Reserve Board, including changes in monetary policies and interest rates; customer deposit disintermediation; changes in customers acceptance of the Banks products
and services; and the extent and timing of legislative and regulatory actions and reforms.



The forward-looking statements contained in this report speak only as of the date on which such statements are made.



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##### Table of Contents

FINANCIAL CONDITION



General



Total assets increased to $230,881 at June 30, 2005 from $211,802 at December 31, 2004, an increase of $19,079 (or 9%). The increase in assets primarily relates to an increase in total cash and cash equivalents, as
well as net loans. This was partially offset by a decrease in total securities. The increase in cash and cash equivalents of $20,712 was primarily attributable to an increase in deposits of $18,323. This was partially offset by net loan originations
of $3,801.



Loans



The loan portfolio (excluding loans held for sale) increased to $136,651 at
June 30, 2005 from $132,833 at December 31, 2004, an increase of $3,818 (or 3%). The increase in total loans primarily resulted from an increase in construction loans and to a lesser extent from commercial loans. The increase was partially offset by
a decrease in residential and non-residential loans, and to a lesser extent from consumer and other loans. The increase in construction loans primarily reflects new loan originations and customer advances during the period ended June 30, 2005. The
increase in commercial loans was primarily due to the origination of new loans during the period ended June 30, 2005. The decrease in residential and non-residential loans, as well as consumer and other loans, was primarily due to payoff activity
exceeding new loan originations for the period ended June 30, 2005.



Major classifications of loans at June 30, 2005 and December 31, 2004 were as follows:



|                              |  |               |         |   |                   |   |         |              |  |   |                |   |  |     |   
|----------------------------- |  | ------------- | ------- | - | ----------------- | - | ------- | ------------ |  | - | -------------- | - |  | --- | --
|                              |  | June 30, 2005 |         |   | December 31, 2004 |   |         | DollarChange |  |   | Percent Change |  
|Loans secured by real estate: |  |               |         |   |                   |   |         |              |  |   |                |   |  |     |   
|Residential                   |  | $             | 36,834  |   |                   | $ | 39,489  |              |  | $ | (2,655         | ) |  | (7  | )%
|Non-residential               |  |               | 55,060  |   |                   |   | 56,606  |              |  |   | (1,546         | ) |  | (3  | ) 
|Construction                  |  |               | 28,757  |   |                   |   | 21,733  |              |  |   | 7,024          |   |  | 32  |   
|Commercial loans              |  |               | 14,547  |   |                   |   | 13,536  |              |  |   | 1,011          |   |  | 7   |   
|Consumer and Other Loans      |  |               | 1,536   |   |                   |   | 1,621   |              |  |   | (85            | ) |  | (5  | ) 
|                              |  |               |         |   |                   |   |         |              |  |   |                |   |  |     |   
|Total Loans                   |  |               | 136,734 |   |                   |   | 132,985 |              |  |   | 3,749          |   |  | 3   |   
|                              |  |               |         |  
|Allowance for loan losses     |  |               | (2,268  | ) |                   |   | (2,216  | )            |  |   | (52            | ) |  | 2   |   
|Deferred loan fees, net       |  |               | (83     | ) |                   |   | (152    | )            |  |   | 69             |   |  | (45 | ) 
|                              |  |               |         |   |                   |   |         |              |  |   |                |   |  |     |   
|Total loans, net              |  | $             | 134,383 |   |                   | $ | 130,617 |              |  | $ | 3,766          |   |  | 3   | % 
|                              |  |               |         |   |                   |   |         |              |  |   |                |   |  |     |   



Small Business
Administration (SBA) loans held for sale at June 30, 2005 and December 31, 2004 were $1,758 and $1,994, respectively.



Non-performing Loans and the Allowance for Loan Losses



It is the Banks policy to manage its loan portfolio to facilitate early recognition of problem loans. The Bank commences internal collection efforts
once a loan payment is more than 15 days past due. The Banks data processing system generates delinquency reports on all of the Banks loans weekly, and management reviews the loan portfolio to determine if past due loans should be placed
on non-accrual status. Unless the customer is working with the Bank toward repayment, once a loan payment is 90 days past due, the Bank generally initiates appropriate collection or legal action.



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##### Table of Contents

The following table summarizes, by type of loan, the recorded investment in non-performing loans at June
30, 2005 and December 31, 2004. Amounts are shown for (i) loans that were past due 90 days or more, segregated between those on non-accrual status and those that were still accruing interest, and (ii) loans that were current or past due less than 90
days for which interest payments were being applied to reduce principal balances.



|                                                                                                                         |  |               |      |   |                   |   |      |  
|------------------------------------------------------------------------------------------------------------------------ |  | ------------- | ---- | - | ----------------- | - | ---- | -
|                                                                                                                         |  | June 30, 2005 |      |   | December 31, 2004 |  
|Loans past due 90 days or more                                                                                           |  |               |      |   |                   |   |      |  
|Loans on non-accrual status:                                                                                             |  |               |      |   |                   |   |      |  
|Loans secured by real estate                                                                                             |  | $             | 225  |   |                   | $ | 167  |  
|Commercial loans                                                                                                         |  |               | 40   |   |                   |   | 87   |  
|Consumer and other loans                                                                                                 |  |               | 20   |   |                   |   | 30   |  
|                                                                                                                         |  |               |      |   |                   |   |      |  
|                                                                                                                         |  |               | 285  |   |                   |   | 284  |  
|                                                                                                                         |  |               |      |   |                   |   |      |  
|Loans on accrual status:                                                                                                 |  |               |      |   |                   |   |      |  
|Loans secured by real estate                                                                                             |  |               | 222  |   |                   |   | 321  |  
|Commercial loans                                                                                                         |  |               | 2    |   |                   |   |     |  
|Consumer and other loans                                                                                                 |  |               | 5    |   |                   |   | 8    |  
|                                                                                                                         |  |               |      |   |                   |   |      |  
|                                                                                                                         |  |               | 229  |   |                   |   | 329  |  
|                                                                                                                         |  |               |      |   |                   |   |      |  
|Total loans past due 90 days or more                                                                                     |  |               | 514  |   |                   |   | 613  |  
|                                                                                                                         |  |               |      |   |                   |   |      |  
|Loans current or past due less than 90 days for which interest payments were being applied to reduce principal balances: |  |               |      |   |                   |   |      |  
|Loans secured by real estate                                                                                             |  |               | 80   |   |                   |   | 173  |  
|Commercial loans                                                                                                         |  |               | 312  |   |                   |   | 124  |  
|Consumer and other loans                                                                                                 |  |               |     |   |                   |   | 5    |  
|                                                                                                                         |  |               |      |   |                   |   |      |  
|                                                                                                                         |  |               | 392  |   |                   |   | 302  |  
|                                                                                                                         |  |               |      |   |                   |   |      |  
|Total non-performing loans                                                                                               |  | $             | 906  |   |                   | $ | 915  |  
|                                                                                                                         |  |               |      |   |                   |   |      |  
|Ratio of total non-performing loans to total loans outstanding                                                           |  |               | 0.66 | % |                   |   | 0.69 | %
|                                                                                                                         |  |               |      |   |                   |   |      |  



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The following table sets forth changes in the allowance for loan losses for the periods indicated.



|                               |  |                             |       |   |                           |   |       |      |  |   |       |   |  |   |       |  
|------------------------------ |  | --------------------------- | ----- | - | ------------------------- | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                               |  | Three Months Ended June 30, |       |   | Six Months Ended June 30, |  
|                               |  | 2005                        |       |   | 2004                      |   |       | 2005 |  |   | 2004  |  
|Balance at beginning of period |  | $                           | 2,239 |   |                           | $ | 2,339 |      |  | $ | 2,216 |   |  | $ | 2,387 |  
|Provision for loan losses      |  |                             | 48    |   |                           |   | (39   | )    |  |   | 102   |   |  |   | (550  | )
|Loan charge-offs               |  |                             | (21   | ) |                           |   | (3    | )    |  |   | (52   | ) |  |   | (7    | )
|Recoveries                     |  |                             | 2     |   |                           |   | 5     |      |  |   | 2     |   |  |   | 472   |  
|                               |  |                             |       |   |                           |   |       |      |  |   |       |   |  |   |       |  
|Balance at end of period       |  | $                           | 2,268 |   |                           | $ | 2,302 |      |  | $ | 2,268 |   |  | $ | 2,302 |  
|                               |  |                             |       |   |                           |   |       |      |  |   |       |   |  |   |       |  



During the six months
ended June 30, 2004, The Bank recovered $690, of which $460 was a recovery of previously charged-off principal on loans to one borrower, and $216 was a recovery of interest that was subsequently applied to income. The ratios of the allowance for
loan losses to total loans and to non-performing loans were 1.64% and 250% respectively, at June 30, 2005, compared to 1.66% and 242%, respectively, at December 31, 2004.



Securities



Total securities decreased to $45,188 at June 30, 2005 from $50,834 at December 31, 2004, a decrease of $5,646 (or 11%). The decrease in the securities
portfolio was primarily due to maturities in the available for sale and held to maturity portfolios during the period ended June 30, 2005.



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##### Table of Contents

The following table sets forth the amortized cost and estimated fair value of the securities portfolio at
the dates indicated.



|                           |  |               |        |                    |   |               |  |                    |        |  |   |       
|-------------------------- |  | ------------- | ------ | ------------------ | - | ------------- |  | ------------------ | ------ |  | - | ------
|                           |  | June 30, 2005 |        | December 31, 2004 
|                           |  | AmortizedCost |        | EstimatedFairValue |   | AmortizedCost |  | EstimatedFairValue
|Available for sale         |  |               |        |                    |   |               |  |                    |        |  |   |       
|U.S. Agency securities     |  | $             | 1,001  |                    | $ | 1,002         |  | $                  | 2,007  |  | $ | 2,004 
|Mortgage-backed securities |  |               | 805    |                    |   | 792           |  |                    | 970    |  |   | 958   
|                           |  |               |        |                    |   |               |  |                    |        |  |   |       
|                           |  | $             | 1,806  |                    | $ | 1,794         |  | $                  | 2,977  |  | $ | 2,962 
|                           |  |               |        |                    |   |               |  |                    |        |  |   |       
|Held to maturity           |  |               |        |                    |   |               |  |                    |        |  |   |       
|U.S. Agency securities     |  | $             | 36,700 |                    | $ | 36,397        |  | $                  | 40,688 |  | $ | 40,476
|Mortgage-backed securities |  |               | 3,626  |                    |   | 3,623         |  |                    | 4,117  |  |   | 4,143 
|Municipal bonds            |  |               | 2,993  |                    |   | 2,987         |  |                    | 2,992  |  |   | 3,003 
|Other                      |  |               | 75     |                    |   | 75            |  |                    | 75     |  |   | 75    
|                           |  |               |        |                    |   |               |  |                    |        |  |   |       
|                           |  | $             | 43,394 |                    | $ | 43,082        |  | $                  | 47,872 |  | $ | 47,697
|                           |  |               |        |                    |   |               |  |                    |        |  |   |       
|Total                      |  | $             | 45,200 |                    | $ | 44,876        |  | $                  | 50,849 |  | $ | 50,659
|                           |  |               |        |                    |   |               |  |                    |        |  |   |       



Deposits



Deposits are the primary source of funds for the Company. Deposits are
obtained from individuals, partnerships, small and medium size businesses and professionals in the Companys market area. The Company does not accept brokered deposits.



The following table indicates the composition of deposits at the dates indicated.



|                                       |  |               |         |                   |   |               |  |   |                |   |  |     |  
|-------------------------------------- |  | ------------- | ------- | ----------------- | - | ------------- |  | - | -------------- | - |  | --- | -
|                                       |  | June 30, 2005 |         | December 31, 2004 |   | Dollar Change |  |   | Percent Change |  
|Demand (non-interest bearing)          |  | $             | 50,773  |                   | $ | 42,225        |  | $ | 8,548          |   |  | 20  | %
|Money market demand and NOW            |  |               | 44,905  |                   |   | 39,561        |  |   | 5,344          |   |  | 14  |  
|Regular, club and money market savings |  |               | 36,500  |                   |   | 42,202        |  |   | (5,702         | ) |  | (14 | )
|Time                                   |  |               | 63,272  |                   |   | 53,139        |  |   | 10,133         |   |  | 19  |  
|                                       |  |               |         |                   |   |               |  |   |                |   |  |     |  
|Total deposits                         |  | $             | 195,450 |                   | $ | 177,127       |  | $ | 18,323         |   |  | 10  | %
|                                       |  |               |         |                   |   |               |  |   |                |   |  |     |  



The increase in
deposits was primarily related to the increase of approximately $10,133 (or 19%) in time deposits and $8,548 (or 20%) in demand accounts, as well as an increase of $5,344 (or 14%) in money market demand and NOW accounts. This was partially offset by
a decrease in regular, club and preferred rate savings of $5,702 (or 14%). The increase in demand accounts is primarily attributable to balances maintained in internal Bank checking accounts to fund the payment of incoming official checks as well as
customer-related activity. The increase in money market demand and NOW accounts was primarily attributable to activity on attorney-related accounts. The decrease in regular, club and money market savings was due to a decline in customer balances.
The increase in time deposits was primarily attributable to



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increases of $10,542 in 12-17 month certificates, $3,060 in 36-47 month time deposits, $1,754 in 24-30 month time
deposits and $1,667 in 18-23 month time deposits. This was partially offset by decreases of $2,315 in 48-59 month time deposits, $2,149 in 91-180 day time deposits and $2,106 in 181-364 day time deposits. Certificates of deposit in denominations of
$100 or more were $15,211 at June 30, 2005 as compared to $12,741 at December 31, 2004, an increase of $2,470 (or 19%).



Liquidity and Capital Resources



At June 30, 2005, total short-term investments, which are made up of federal funds sold and securities maturing or callable in one year or less, totaled
$40,513. The primary liquidity of the Company is measured by the ratio of net cash, short-term investments and other liquidity sources to deposits and short-term liabilities. The primary liquidity ratio at June 30, 2005 was 20.73%, compared to
20.04% at December 31, 2004. The Bank also calculates a secondary liquidity ratio which contemplates loan sales and loan payoffs anticipated to occur within one year and the maturity of available and held to maturity securities beyond one year. The
Banks secondary liquidity ratio at June 30, 2005 was 33.59%, compared to 33.38% at December 31, 2004. The increase in primary and secondary liquidity ratios in 2005 is primarily related to the increase in cash and cash equivalents at June 30,
2005 as compared to December 31, 2004. The Companys internal guideline is to generally maintain a primary liquidity ratio of 10 to 15% and a secondary liquidity ratio of 20% or more, although a higher primary ratio may be maintained from time
to time depending on cash flow patterns and loan demand.



Net cash provided by operating activities was $1,727 for the six months ended June 30, 2005 as compared to $1,953 for the six months ended June 30, 2004, primarily due to a decline in cash used for the origination of mortgage loans and SBA
loans held-for-sale. This was offset by a decline in proceeds from sales of loans held for sale and, to a lesser extent, in net income for the first six months of 2005 compared to the same period last year. Net cash provided by investing activities
was $1,755 for the six months ended June 30, 2005 as compared to $31,016 in net cash used in investing activities for the first six months of 2004. The decrease in cash used in investing activities of $32,771 was primarily due to no purchases in the
held-to-maturity investment portfolio in the first six months of 2005 as compared to purchases of $36,152 in the first six months of 2004. The increase in net cash provided by financing activities of $17,890 for the six months ended June 30, 2005
primarily resulted from an increase of $20,660 in cash provided by customers deposits. Cash and cash equivalents increased $20,712 for the six months ended June 30, 2005 compared to a decrease of $29,723 for the six months ended June 30,
2004.



At June 30, 2005, the Company had outstanding
loan commitments under unused lines of credit of $20,875 and outstanding letters of credit of $1,230.



At June 30, 2005 and December 31, 2004, the Companys consolidated leverage capital ratio was 11.0% and 10.2%, respectively. At June 30, 2005 and
December 31, 2004, the Companys consolidated Tier 1 risk-based capital ratio was 14.5% and 14.2%, respectively. The Companys consolidated total risk-based capital ratio at June 30, 2005 and December 31, 2004 was 15.8% and 15.5%,
respectively. The Banks regulatory capital ratios at these dates were substantially the same as the consolidated ratios, and the Bank was classified as a well-capitalized institution for regulatory purposes.



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##### Table of Contents

RESULTS OF OPERATIONS



General



The Companys results of operations depend primarily on its net interest income, which is the difference between the interest income on earning assets, such as loans and securities, and the interest expense paid
on deposits and borrowings. Results of operations are also affected by non-interest income and expense, the provision for loan losses and income tax expense. Non-interest income includes banking service fees and charges, income on bank-owned life
insurance, and gains and losses on sales of securities available for sale and loans held for sale. The Companys non-interest expense consists primarily of salaries and employee benefits, occupancy and equipment expenses, data processing
expenses and professional fees. Results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory authorities.



Critical Accounting Policies



In the course of the Companys normal business activity, management
must select and apply many accounting policies and methodologies that lead to the financial results presented in the consolidated financial statements of the Company. Some of these policies are more critical than others. Management considers the
accounting policy relating to the allowance for loan losses to be a critical accounting policy because of the uncertainty and subjectivity inherent in estimating the levels of allowance needed to cover probable credit losses within the loan
portfolio and the material effect that these estimates can have on the Companys results of operations. While management uses the best available information to determine the allowance for loan losses, future adjustments to the allowance may be
necessary based on a variety of factors, including changes in economic and real estate market conditions, particularly in Southwestern Fairfield County, Connecticut.



All accounting policies are important and readers of this report should review these policies, as included in Note 1 to the
Consolidated Financial Statements in the Companys Annual Report on Form 10-KSB, to gain a greater understanding of how the Companys financial performance is reported.



Comparative Analysis of Operating Results for the Three Months Ended June 30, 2005 and June 30, 2004



Net Income. Net income was $303 for the three months ended June 30,
2005 compared to $422 for the three months ended June 30, 2004, a decrease of $119 (or 28%). Diluted earnings per common share were $0.23 and 0.33 for the three months ended June 30, 2005 and 2004, respectively, based on weighted average common
shares of 1,312,569 and 1,290,610, respectively. The annualized return on average common stockholders equity was 5.15% and 7.87% for the three months ended June 30, 2005 and 2004, respectively. The annualized return on average assets was 0.56%
for the three months ended June 30, 2005 and 0.77% for the three months ended June 30, 2004.



The lower net income for the three months ended June 30, 2005 was primarily due to the absorption of $211 in costs associated with the Merger of
Cornerstone Bancorp, Inc. and New Alliance Bancshares, Inc. scheduled to close early in 2006 as well as a higher provision for loan losses. This was partially offset by the increases in income from loans and gains on the sales of loans and loan
servicing.



Net Interest Income. Net interest income is
the difference between the interest income the Company



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earns on its loans, securities and other earning assets, and the interest cost of deposits and other interest-bearing
liabilities necessary to fund these earning assets. It is the primary component of the Companys earnings.



Net interest income was $2,377 for the three months ended June 30, 2005, an increase of $291 (or 14%) from the $2,086 reported for the three months ended
June 30, 2004. The average yield on interest-earning assets increased 99 basis points for the quarter ended June 30, 2005 compared to June 30, 2004, while the average rate paid on interest-bearing liabilities increased 27 basis points. The higher
net interest income for the three months ended June 30, 2005 was primarily due to the growth in the loan portfolio as well as the higher level of interest rates. Total interest income increased as earning assets were shifted into higher yielding
loans. These changes resulted in a 78 basis point increase in the net interest margin to 4.86% for the quarter ended June 30, 2005 compared to 4.08% for the quarter ended June 30, 2004.



Interest Income. Average earning assets for the three months ended
June 30, 2005 were $198,139 compared to $207,249 for the three months ended June 30, 2004, a decrease of $9,110 (or 4%). Total interest income, which is a function of the volume of interest-earning assets and their related rates, was $3,030 for the
three months ended June 30, 2005 compared to $2,662 for the three months ended June 30, 2004, representing an increase of $368 (or 14%).



Loans represent the largest component of interest-earning assets. Interest income on loans was $2,566 for the three months ended June 30, 2005 compared to
$2,218 for the three months ended June 30, 2004, an increase of $348 (or 16%). Average loans outstanding in the three months ended June 30, 2005 were $139,758 compared to $127,959 during the three months ended June 30, 2004, an increase of $11,799
(or 9%). The average yield on loans increased 39 basis point to 7.36% at June 30, 2005 from 6.97% at June 30, 2004 due to higher loan volume as well as a 1.75% increase in the prime rate.



Average investments in securities and federal funds sold were $58,381 for the three months ended June 30, 2005 compared to
$79,290 for the three months ended June 30, 2004, a decrease of $20,909 (or 26%). Related income increased to $464 for the three months ended June 30, 2005 from $444 for the three months ended June 30, 2004, an increase of $20 (or 5%). Average
investments in securities, not including federal funds sold, increased by $1,679 (or 4%) during the three months ended June 30, 2005. Average federal funds sold decreased by $22,588 (or 67%). The decrease in federal funds sold was due to an increase
in loan volume as well as a decrease in average deposits.



Interest Expense. Interest expense was $653 for the three months ended June 30, 2005 compared to $576 for the three months ended June 30, 2004, an increase of $77 (or 13%). Interest expense is a function of the volume of
interest-bearing liabilities and their related rates. Average interest-bearing liabilities during the three months ended June 30, 2005 were $147,110 compared to $153,536 during the three months ended June 30, 2004, a decrease of $6,426 or (4%). The
average rate paid on interest-bearing liabilities increased 27 basis points to 1.78% for the quarter ended June 30, 2005 compared to 1.51% for the quarter ended June 30, 2004.



Provision for Loan Losses. The periodic provision for loan losses represents the amount necessary to adjust the
allowance for loan losses to managements estimate of probable credit losses inherent in the existing loan portfolio at the reporting date. Managements determination of the allowance for loan losses is based on the results of continuing
reviews of individual loans and borrower relationships, particularly in the



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commercial and commercial real estate loan portfolios. A review of the quality of the loan portfolio is conducted
internally by management on a quarterly basis, using a consistently-applied methodology, and the results are presented to the Board of Directors for approval. The evaluation covers individual borrowers whose aggregate loans are greater than $100, as
well as all adversely-classified loans. Management also considers factors such as the borrowers financial condition, historical and expected ability to make loan payments and underlying collateral values. The determination of the allowance for
loan losses also considers the level of past due loans, the Banks historical loan loss experience, changes in loan portfolio mix, geographic and borrower concentrations and current economic conditions. The allowance for loan losses is also
reduced by charge-offs and increased by recoveries. Managements evaluation of the allowance for loan losses indicated that the necessary provision for loan losses was $48 for the three months ended June 30, 2005 and ($39) for the three months
ended June 30, 2004.



Non-interest Income. Non-interest
income was $552 for the three months ended June 30, 2005 compared to $477 for the three months ended June 30, 2004, an increase of $75 (or 16%). The increase in non-interest income was primarily attributable to an increase of $74 in the net gain on
sale of loans and loan servicing for the three months ended June 30, 2005 as compared to June 30, 2004 and to a lesser extent to the origination and sale of mortgage loans.



Non-interest Expense. Total non-interest expense was $2,279 for the three months ended June 30, 2005 and $1,920 for
the three months ended June 30, 2004, an increase of $359 (or 19%). The increase in salaries and employee benefits results from an increase in salaries and bonuses for the six months ended June 30, 2005 compared to June 30, 2004. The increase in
professional fess primarily relates to $211 thousand in Merger-related expenses absorbed in the quarter ending June 30, 2005, which was partially offset by a decline in legal fees. Increased occupancy expense for the three months ended June 30, 2005
includes additional expenses related to the Norwalk branch and increased rental expense at five offices.



The following table summarizes the dollar amounts for each category of non-interest expense, and the dollar and percent changes:



|                               |  |                             |       |                                  |   |          |  |   |          |   |  |     |  
|------------------------------ |  | --------------------------- | ----- | -------------------------------- | - | -------- |  | - | -------- | - |  | --- | -
|                               |  | Three months Ended June 30, |       | Increase (Decrease) 2005 vs 2004 |  
|Category                       |  | 2005                        |       | 2004                             |   | $ Change |  |   | % Change |  
|Salaries and employee benefits |  | $                           | 1,189 |                                  | $ | 1,093    |  | $ | 96       |   |  | 9   | %
|Occupancy                      |  |                             | 234   |                                  |   | 177      |  |   | 57       |   |  | 32  |  
|Furniture and equipment        |  |                             | 107   |                                  |   | 114      |  |   | (7       | ) |  | (6  | )
|Data processing                |  |                             | 127   |                                  |   | 119      |  |   | 8        |   |  | 7   |  
|Professional fees              |  |                             | 293   |                                  |   | 94       |  |   | 199      |   |  | 212 |  
|Advertising and promotion      |  |                             | 41    |                                  |   | 42       |  |   | (1       | ) |  | (2  | )
|Other                          |  |                             | 288   |                                  |   | 281      |  |   | 7        |   |  | 2   |  
|                               |  |                             |       |                                  |   |          |  |   |          |   |  |     |  
|Total non-interest expense     |  | $                           | 2,279 |                                  | $ | 1,920    |  | $ | 359      |   |  | 19  | %
|                               |  |                             |       |                                  |   |          |  |   |          |   |  |     |  



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The following table summarizes dollar amounts for each category of non-interest expense as a percentage
of total operating income (interest income plus non-interest income). Operating income increased by $443 (or 14%) in the first quarter of 2005 compared to the same period in 2004.



|                               |  |                             |   |  |       |  
|------------------------------ |  | --------------------------- | - |  | ----- | -
|                               |  | Three months Ended June 30, |  
|Category                       |  | 2005                        |   |  | 2004  |  
|Salaries and employee benefits |  | 33.19                       | % |  | 34.82 | %
|Occupancy                      |  | 6.53                        |   |  | 5.64  |  
|Furniture and equipment        |  | 2.99                        |   |  | 3.63  |  
|Data processing                |  | 3.55                        |   |  | 3.79  |  
|Professional fees              |  | 8.18                        |   |  | 2.99  |  
|Advertising and promotion      |  | 1.14                        |   |  | 1.34  |  
|Other                          |  | 8.04                        |   |  | 8.96  |  
|                               |  |                             |   |  |       |  
|Total non-interest expense     |  | 63.62                       | % |  | 61.17 | %
|                               |  |                             |   |  |       |  



Income Taxes.
The provision for income taxes increased to $299 for the three months ended June 30, 2005 from $260 for the three months ended June 30, 2004, an increase of $39 or (15%). The effective tax rate for the three months ended June 30, 2005 was 49.7%, due
to the non-deductibility of $211 in merger-related expenses compared to 38.2% for the three months ended June 30, 2004.



Comparative Analysis of Operating Results for the Six Months Ended June 30, 2005 and June 30, 2004



Net Income. Net income was $675 for the six months ended June 30, 2005 compared to $1,477 for the six months ended
June 30, 2004, a decrease of $802 (or 54%). Diluted earnings per common share were $0.51 and 1.15 for the six months ended June 30, 2005 and 2004, respectively, based on weighted average common shares of 1,312,262 and 1,283,797, respectively. The
annualized return on average common stockholders equity was 5.85% and 14.03% for the six months ended June 30, 2005 and 2004, respectively. The annualized return on average assets was 0.63% for the six months ended June 30, 2005 and 1.36% for
the six months ended June 30, 2004.



The lower net
income for the six months ended June 30, 2005 was primarily due to a one-time recovery of $460 on a previously charged off loan during the six-month period ended June 30, 2004, as well as $495 in one-time life insurance proceeds received during the
six-month period ended June 30, 2004. This was partially offset by the increase in income from loans, an increase of $563 (or 12%) which was partially offset by increase non-interest expense of $257 (or 6%) for the period ended June 30, 2005.



Net Interest Income. Net interest income is the
difference between the interest income the Company earns on its loans, securities and other earning assets, and the interest cost of deposits and other interest-bearing liabilities necessary to fund these earning assets. It is the primary component
of the Companys earnings.



Net interest income was $4,797
for the six months ended June 30, 2005, an increase of $605 (or 14%) from the $4,192 reported for the six months ended June 30, 2004. The average yield on interest-earning assets increased 88 basis points for the quarter ended June 30, 2005 compared
to June 30, 2004, while the



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average rate paid on interest-bearing liabilities increased 10 basis points. The higher net interest income for the six
months ended June 30, 2005 was primarily due to the growth in the loan portfolio and the investment portfolio. Total interest income increased as earning assets were shifted into higher yielding loans and investment securities and out of lower
yielding federal funds during 2004. These changes resulted in an 81 basis point increase in the net interest margin to 4.93% for the quarter ended June 30, 2005 compared to 4.12% for the quarter ended June 30, 2004.



Interest Income. Average earning assets for the six months ended June
30, 2005 were $197,744 compared to $205,474 for the six months ended June 30, 2004, a decrease of $7,730 (or 4%). Total interest income, which is a function of the volume of interest-earning assets and their related rates, was $6,047 for the six
months ended June 30, 2005 compared to $5,415 for the six months ended June 30, 2004, representing an increase of $632 (or 12%).



Loans represent the largest component of interest-earning assets. Interest income on loans was $5,119 for the six months ended June 30, 2005 compared to
$4,556 for the six months ended June 30, 2004, an increase of $563 (or 12%). Average loans outstanding in the six months ended June 30, 2005 were $138,952 compared to $126,310 during the six months ended June 30, 2004, an increase of $12,642 (or
10%). The average yield on loans increased 18 basis points to 7.43% at June 30, 2005 from 7.25% at June 30, 2004. During the six months ended June 30, 2004, $216 in interest income on a previously charged off loan contributed to the higher than
normal average yield on loans for the period.



Average
investments in securities and federal funds sold were $58,792 for the six months ended June 30, 2005 compared to $79,164 for the six months ended June 30, 2004, a decrease of $20,372 (or 26%). Related income increased to $928 for the six months
ended June 30, 2005 from $859 for the six months ended June 30, 2004, an increase of $69 (or 8%). Average investments in securities, not including federal funds sold, increased by $7,314 (or 18%) during the six months ended June 30, 2005. Average
federal funds sold decreased by $27,686 (or 74%). The increase in the average volume of securities from year to year contributed to an increase in related income which was partially offset by a decline in the volume of federal funds sold.



Interest Expense. Interest expense was $1,250 for the
six months ended June 30, 2005 compared to $1,223 for the six months ended June 30, 2004, an increase of $27 (or 2%). Interest expense is a function of the volume of interest-bearing liabilities and their related rates. Average interest-bearing
liabilities during the six months ended June 30, 2005 were $147,285 compared to $152,833 during the six months ended June 30, 2004, a decrease of $5,548 or (4%). The average rate paid on interest-bearing liabilities increased 10 basis points to
1.71% for the quarter ended June 30, 2005 compared to 1.61% for the quarter ended June 30, 2004.



Provision for Loan Losses. The periodic provision for loan losses represents the amount necessary to adjust the allowance for loan losses to
managements estimate of probable credit losses inherent in the existing loan portfolio at the reporting date. Managements determination of the allowance for loan losses is based on the results of continuing reviews of individual loans
and borrower relationships, particularly in the commercial and commercial real estate loan portfolios. A review of the quality of the loan portfolio is conducted internally by management on a quarterly basis, using a consistently-applied
methodology, and the results are presented to the Board of Directors for approval. The evaluation covers individual borrowers whose aggregate loans are greater than $100, as well as all adversely-classified loans. Management also



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considers factors such as the borrowers financial condition, historical and expected ability to make loan payments
and underlying collateral values. The determination of the allowance for loan losses also considers the level of past due loans, the Banks historical loan loss experience, changes in loan portfolio mix, geographic and borrower concentrations
and current economic conditions. The allowance for loan losses is also reduced by charge-offs and increased by recoveries. Managements evaluation of the allowance for loan losses indicated that the necessary provision for loan losses was $102
for the six months ended June 30, 2005 and ($550) for the six months ended June 30, 2004. Approximately $460 in principal was recovered during the quarter ending June 30, 2004 on loans to one borrower which were charged-off in December 2000.



Non-interest Income. Non-interest income was $862 for
the six months ended June 30, 2005 compared to $1,459 for the six months ended June 30, 2004, a decrease of $597 (or 41%). This decrease was primarily attributable to the net proceeds of $495 received by the Bank on a key man life insurance policy
on the former Vice Chairman during the period ended June 30, 2004. The decline in non-interest income was also attributable to a decrease of $118 in the net gain on sale of loans and loan servicing for the six months ended June 30, 2005 due to the
reduced activity as compared to the six months ended June 30, 2004.



Non-interest Expense. Total non-interest expense was $4,341 for the six months ended June 30, 2005 and $4,084 for the six months ended June 30, 2004, an increase of $257 (or 6%). The increase in total
non-interest expense relates to $220 in Merger-related expenses absorbed during the six months ended June 30, 2005 and additional occupancy expenses related to the Norwalk branch and increased rental expense at five offices. This was partially
offset by an increase of $216 of benefit accruals during the period ending June 30, 2004 for the retirement and medical benefits of the former Vice Chairman who passed away on January 8, 2004.



The following table summarizes the dollar amounts for each category of
non-interest expense, and the dollar and percent changes:



|                               |  |                           |       |                                  |   |          |  |   |          |   |  |     |   
|------------------------------ |  | ------------------------- | ----- | -------------------------------- | - | -------- |  | - | -------- | - |  | --- | --
|                               |  | Six months Ended June 30, |       | Increase (Decrease) 2005 vs 2004 |  
|Category                       |  | 2005                      |       | 2004                             |   | $ Change |  |   | % Change |  
|Salaries and employee benefits |  | $                         | 2,386 |                                  | $ | 2,443    |  | $ | (57      | ) |  | (2  | )%
|Occupancy                      |  |                           | 436   |                                  |   | 366      |  |   | 70       |   |  | 19  |   
|Furniture and equipment        |  |                           | 218   |                                  |   | 228      |  |   | (10      | ) |  | (4  | ) 
|Data processing                |  |                           | 256   |                                  |   | 252      |  |   | 4        |   |  | 2   |   
|Professional fees              |  |                           | 418   |                                  |   | 188      |  |   | 230      |   |  | 122 |   
|Advertising and promotion      |  |                           | 90    |                                  |   | 86       |  |   | 4        |   |  | 5   |   
|Other                          |  |                           | 537   |                                  |   | 521      |  |   | 16       |   |  | 3   |   
|                               |  |                           |       |                                  |   |          |  |   |          |   |  |     |   
|Total non-interest expense     |  | $                         | 4,341 |                                  | $ | 4,084    |  | $ | 257      |   |  | 6   | % 
|                               |  |                           |       |                                  |   |          |  |   |          |   |  |     |   



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##### Table of Contents

The following table summarizes dollar amounts for each category of non-interest expense as a percentage
of total operating income (interest income plus non-interest income). Operating income increased by $35 (or 1%) in the first six month period ended June 30, 2005 compared to the same period in 2004.



|                               |  |                          |   |  |       |  
|------------------------------ |  | ------------------------ | - |  | ----- | -
|                               |  | Six months EndedJune 30, |  
|Category                       |  | 2005                     |   |  | 2004  |  
|Salaries and employee benefits |  | 34.53                    | % |  | 35.54 | %
|Occupancy                      |  | 6.31                     |   |  | 5.32  |  
|Furniture and equipment        |  | 3.16                     |   |  | 3.32  |  
|Data processing                |  | 3.71                     |   |  | 3.67  |  
|Professional fees              |  | 6.05                     |   |  | 2.73  |  
|Advertising and promotion      |  | 1.30                     |   |  | 1.25  |  
|Other                          |  | 7.77                     |   |  | 7.58  |  
|                               |  |                          |   |  |       |  
|Total non-interest expense     |  | 62.83                    | % |  | 59.41 | %
|                               |  |                          |   |  |       |  



Income Taxes.
The provision for income taxes decreased to $541 for the six months ended June 30, 2005 from $640 for the six months ended June 30, 2004, a decrease of $99 or (15%), primarily due to lower income before income tax expense. The effective tax rate for
the six months ended June 30, 2005 was 44.5%, due to the non-deductibility of $220 in merger-related expenses compared to 30.3% for the six months ended June 30, 2004.



Item 3. Controls and Procedures.



An evaluation of the effectiveness of the design and operation of the Companys disclosure controls and procedures as of June 30, 2005 was conducted under the supervision and with the participation of the Chief Executive Officer and
Chief Financial Officer. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures were adequate and designed to ensure that information required to be
disclosed by the Company in this report is recorded, processed, summarized and reported in a timely manner, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required disclosure.



During the quarter ended June 30, 2005, there was no significant change in the Companys internal control over financial reporting that has materially affected or is reasonably likely to materially affect the Companys internal
control over financial reporting.



Reference is made to the
Certifications of the Chief Executive Officer and Chief Financial Officer about these and other matters included as Exhibits 31.1 and 31.2 to this report.



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##### Table of Contents

PART II - Other Information



Item 6. Exhibits.



Exhibits:



31.1-Rule 13a-14(a)/15d-14(a) Certification.



31.2-Rule 13a-14(a)/15d-14(a) Certification.



32.1-Section 1350 Certifications.



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##### Table of Contents

SIGNATURES



In accordance with the
requirements of the Exchange Act, the Registrant caused this report to be

signed on its behalf by the undersigned, thereunto duly
authorized.



CORNERSTONE BANCORP, INC.

(Registrant)



|                      |  |                                           
|--------------------- |  | ------------------------------------------
|Date: August 10, 2005 |  | /s/ Merrill J. Forgotson                  
|                      |  | Merrill J. Forgotson                      
|                      |  | President and Chief Executive Officer     
|                      | 
|Date: August 10, 2005 |  | /s/ Ernest J. Verrico                     
|                      |  | Ernest J. Verrico                         
|                      |  | Vice President and Chief Financial Officer



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