##### Table of Contents

---



United States Securities and Exchange Commission

Washington, D.C. 20549



FORM 10-QSB



(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, 2004



| ̈ | 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



CORNERSTONE BANCORP, INC./CT

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



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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)



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 28, 2004 was 1,254,386.



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



---





---

##### Table of Contents

TABLE OF CONTENTS



|                                                                                        |  |       
|--------------------------------------------------------------------------------------- |  | ------
|                                                                                        |  | PAGE  
|PART I  Financial Information                                                          |  |       
|                                                                                        | 
|Item 1. Financial Statements (Unaudited)                                                |  |       
|                                                                                        | 
|Consolidated Statements of Condition June 30, 2004 and December 31, 2003                |  | 1     
|                                                                                        | 
|Consolidated Statements of Income Three Months Ended June 30, 2004 and 2003             |  | 2     
|                                                                                        | 
|Consolidated Statements of Income Six Months Ended June 30, 2004 and 2003               |  | 3     
|                                                                                        | 
|Consolidated Statements of Stockholders Equity Six Months Ended June 30, 2004 and 2003 |  | 4     
|                                                                                        | 
|Consolidated Statements of Cash Flows Six Months Ended June 30, 2004 and 2003           |  | 5     
|                                                                                        | 
|Notes to Consolidated Financial Statements                                              |  | 6 - 8 
|                                                                                        | 
|Item 2. Managements Discussion and Analysis or Plan of Operation                       |  | 9 - 20
|                                                                                        | 
|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                             |  | 21    
|                                                                                        | 
|Item 5. Other Information                                                               |  | None  
|                                                                                        | 
|Item 6. Exhibits and Reports on Form 8-K                                                |  | 22    
|                                                                                        | 
|Signatures                                                                              |  | 23    





---

##### Table of Contents

Item 1.    Financial Statements





CORNERSTONE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CONDITION

(In thousands, except per share data)



|                                                                                                                                                                                                      |  |                          |         |   |                   |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                                                                      |  | June 30,2004 (unaudited) |         |   | December 31, 2003 |  
|Assets                                                                                                                                                                                                |  |                          |         |   |                   |   |         |  
|Cash and cash equivalents:                                                                                                                                                                            |  |                          |         |   |                   |   |         |  
|Cash and due from banks                                                                                                                                                                               |  | $                        | 15,406  |   |                   | $ | 15,829  |  
|Federal funds sold                                                                                                                                                                                    |  |                          | 17,700  |   |                   |   | 47,000  |  
|                                                                                                                                                                                                      |  |                          |         |   |                   |   |         |  
|Total cash and cash equivalents                                                                                                                                                                       |  |                          | 33,106  |   |                   |   | 62,829  |  
|                                                                                                                                                                                                      |  |                          |         |   |                   |   |         |  
|Securities, including collateral of $6,459 in 2004 and $4,587 in 2003 for borrowings under securities repurchase agreements:                                                                          |  |                          |         |   |                   |   |         |  
|Available for sale, at fair value                                                                                                                                                                     |  |                          | 4,219   |   |                   |   | 11,079  |  
|Held to maturity, at amortized cost (fair value of $52,298 in 2004 and $21,019 in 2003)                                                                                                               |  |                          | 52,424  |   |                   |   | 20,510  |  
|                                                                                                                                                                                                      |  |                          |         |   |                   |   |         |  
|Total securities                                                                                                                                                                                      |  |                          | 56,643  |   |                   |   | 31,589  |  
|                                                                                                                                                                                                      |  |                          |         |   |                   |   |         |  
|Loans held for sale                                                                                                                                                                                   |  |                          | 720     |   |                   |   | 779     |  
|Loans, net of allowance for loan losses of $2,302 at June 30, 2004 and $2,387 at December 31, 2003                                                                                                    |  |                          | 128,296 |   |                   |   | 119,089 |  
|Accrued interest receivable                                                                                                                                                                           |  |                          | 1,017   |   |                   |   | 956     |  
|Federal Home Loan Bank stock, at cost                                                                                                                                                                 |  |                          | 613     |   |                   |   | 613     |  
|Premises and equipment                                                                                                                                                                                |  |                          | 3,309   |   |                   |   | 3,103   |  
|Bank-owned life insurance                                                                                                                                                                             |  |                          | 4,762   |   |                   |   | 5,340   |  
|Deferred income taxes                                                                                                                                                                                 |  |                          | 960     |   |                   |   | 941     |  
|Other assets                                                                                                                                                                                          |  |                          | 695     |   |                   |   | 628     |  
|                                                                                                                                                                                                      |  |                          |         |   |                   |   |         |  
|Total assets                                                                                                                                                                                          |  | $                        | 230,121 |   |                   | $ | 225,867 |  
|                                                                                                                                                                                                      |  |                          |         |   |                   |   |         |  
|Liabilities and Stockholders Equity                                                                                                                                                                  |  |                          |         |   |                   |   |         |  
|Liabilities:                                                                                                                                                                                          |  |                          |         |   |                   |   |         |  
|Deposits:                                                                                                                                                                                             |  |                          |         |   |                   |   |         |  
|Demand (non-interest bearing)                                                                                                                                                                         |  | $                        | 49,715  |   |                   | $ | 44,142  |  
|Money market demand and NOW                                                                                                                                                                           |  |                          | 42,070  |   |                   |   | 37,233  |  
|Regular, club and preferred rate savings                                                                                                                                                              |  |                          | 44,427  |   |                   |   | 42,171  |  
|Time                                                                                                                                                                                                  |  |                          | 60,169  |   |                   |   | 75,172  |  
|                                                                                                                                                                                                      |  |                          |         |   |                   |   |         |  
|Total deposits                                                                                                                                                                                        |  |                          | 196,381 |   |                   |   | 198,718 |  
|Borrowings under securities repurchase agreements                                                                                                                                                     |  |                          | 6,421   |   |                   |   | 4,540   |  
|Accrued interest payable                                                                                                                                                                              |  |                          | 77      |   |                   |   | 108     |  
|Securities purchased, not yet settled                                                                                                                                                                 |  |                          | 3,030   |   |                   |   |        |  
|Other liabilities                                                                                                                                                                                     |  |                          | 2,486   |   |                   |   | 2,014   |  
|                                                                                                                                                                                                      |  |                          |         |   |                   |   |         |  
|Total liabilities                                                                                                                                                                                     |  |                          | 208,395 |   |                   |   | 205,380 |  
|                                                                                                                                                                                                      |  |                          |         |   |                   |   |         |  
|Stockholders equity                                                                                                                                                                                  |  |                          |         |   |                   |   |         |  
|Common stock, par value $0.01 per share. Authorized 5,000,000 shares; issued 1,293,797 shares in 2004 and 1,289,735 shares in 2003;
outstanding 1,249,386 shares in 2004 and 1,237,674 shares in 2003 |  |                          | 13      |   |                   |   | 13      |  
|Additional paid-in capital                                                                                                                                                                            |  |                          | 14,448  |   |                   |   | 14,298  |  
|Retained earnings                                                                                                                                                                                     |  |                          | 8,449   |   |                   |   | 7,253   |  
|Treasury stock, at cost (44,411 shares in 2004 and 52,061 shares in 2003)                                                                                                                             |  |                          | (465    | ) |                   |   | (545    | )
|Unearned restricted stock awards                                                                                                                                                                      |  |                          | (713    | ) |                   |   | (558    | )
|Accumulated other comprehensive income, net of taxes                                                                                                                                                  |  |                          | (6      | ) |                   |   | 26      |  
|                                                                                                                                                                                                      |  |                          |         |   |                   |   |         |  
|Total stockholders equity                                                                                                                                                                            |  |                          | 21,726  |   |                   |   | 20,487  |  
|                                                                                                                                                                                                      |  |                          |         |   |                   |   |         |  
|Total liabilities and stockholders equity                                                                                                                                                            |  | $                        | 230,121 |   |                   | $ | 225,867 |  
|                                                                                                                                                                                                      |  |                          |         |   |                   |   |         |  



See accompanying notes to unaudited
consolidated financial statements.



1



---

##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED JUNE 30, 2004 AND 2003

(In thousands, except per share data)

(unaudited)



|                                                    |  |                             |           |   |      |   |          
|--------------------------------------------------- |  | --------------------------- | --------- | - | ---- | - | ---------
|                                                    |  | Three Months Ended June 30,
|                                                    |  | 2004                        |           |   | 2003
|Interest income:                                    |  |                             |           |   |      |   |          
|Loans                                               |  | $                           | 2,218     |   |      | $ | 2,189    
|Securities                                          |  |                             | 375       |   |      |   | 432      
|Federal funds sold                                  |  |                             | 69        |   |      |   | 135      
|                                                    |  |                             |           |   |      |   |          
|Total interest income                               |  |                             | 2,662     |   |      |   | 2,756    
|                                                    |  |                             |           |   |      |   |          
|Interest expense:                                   |  |                             |           |   |      |   |          
|Deposits                                            |  |                             | 558       |   |      |   | 754      
|Borrowings                                          |  |                             | 18        |   |      |   | 21       
|                                                    |  |                             |           |   |      |   |          
|Total interest expense                              |  |                             | 576       |   |      |   | 775      
|                                                    |  |                             |           |   |      |   |          
|Net interest income                                 |  |                             | 2,086     |   |      |   | 1,981    
|Provision for loan losses                           |  |                             | (39       | ) |      |   | 70       
|                                                    |  |                             |           |   |      |   |          
|Net interest income after provision for loan losses |  |                             | 2,125     |   |      |   | 1,911    
|                                                    |  |                             |           |   |      |   |          
|Non-interest income:                                |  |                             |           |   |      |   |          
|Gain on sale of loans and loan servicing, net       |  |                             | 90        |   |      |   | 306      
|Deposit service charges                             |  |                             | 128       |   |      |   | 113      
|Bank-owned life insurance                           |  |                             | 48        |   |      |   | 49       
|Other                                               |  |                             | 211       |   |      |   | 199      
|                                                    |  |                             |           |   |      |   |          
|Total non-interest income                           |  |                             | 477       |   |      |   | 667      
|                                                    |  |                             |           |   |      |   |          
|Non-interest expense:                               |  |                             |           |   |      |   |          
|Salaries and employee benefits                      |  |                             | 1,093     |   |      |   | 1,030    
|Occupancy                                           |  |                             | 177       |   |      |   | 180      
|Furniture and equipment                             |  |                             | 114       |   |      |   | 101      
|Data processing                                     |  |                             | 119       |   |      |   | 140      
|Professional fees                                   |  |                             | 94        |   |      |   | 83       
|Advertising and promotion                           |  |                             | 42        |   |      |   | 41       
|Other                                               |  |                             | 281       |   |      |   | 325      
|                                                    |  |                             |           |   |      |   |          
|Total non-interest expense                          |  |                             | 1,920     |   |      |   | 1,900    
|                                                    |  |                             |           |   |      |   |          
|Income before income tax expense                    |  |                             | 682       |   |      |   | 678      
|Income tax expense                                  |  |                             | 260       |   |      |   | 261      
|                                                    |  |                             |           |   |      |   |          
|Net income                                          |  | $                           | 422       |   |      | $ | 417      
|                                                    |  |                             |           |   |      |   |          
|Earnings per common share (Note B):                 |  |                             |           |   |      |   |          
|Basic                                               |  | $                           | 0.35      |   |      | $ | 0.35     
|Diluted                                             |  |                             | 0.33      |   |      |   | 0.33     
|                                                    |  |                             |           |   |      |   |          
|Weighted average common shares (Note B):            |  |                             |           |   |      |   |          
|Basic                                               |  |                             | 1,208,597 |   |      |   | 1,200,335
|Diluted                                             |  |                             | 1,290,610 |   |      |   | 1,249,422



See accompanying notes to unaudited
consolidated financial statements.



2



---

##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003

(In thousands, except per share data)

(unaudited)



|                                                    |  |                           |           |   |      |   |          
|--------------------------------------------------- |  | ------------------------- | --------- | - | ---- | - | ---------
|                                                    |  | Six Months Ended June 30,
|                                                    |  | 2004                      |           |   | 2003
|Interest income:                                    |  |                           |           |   |      |   |          
|Loans                                               |  | $                         | 4,556     |   |      | $ | 4,515    
|Securities                                          |  |                           | 693       |   |      |   | 859      
|Federal funds sold                                  |  |                           | 166       |   |      |   | 233      
|                                                    |  |                           |           |   |      |   |          
|Total interest income                               |  |                           | 5,415     |   |      |   | 5,607    
|                                                    |  |                           |           |   |      |   |          
|Interest expense:                                   |  |                           |           |   |      |   |          
|Deposits                                            |  |                           | 1,191     |   |      |   | 1,497    
|Borrowings                                          |  |                           | 32        |   |      |   | 40       
|                                                    |  |                           |           |   |      |   |          
|Total interest expense                              |  |                           | 1,223     |   |      |   | 1,537    
|                                                    |  |                           |           |   |      |   |          
|Net interest income                                 |  |                           | 4,192     |   |      |   | 4,070    
|Provision for loan losses                           |  |                           | (550      | ) |      |   | 175      
|                                                    |  |                           |           |   |      |   |          
|Net interest income after provision for loan losses |  |                           | 4,742     |   |      |   | 3,895    
|                                                    |  |                           |           |   |      |   |          
|Non-interest income:                                |  |                           |           |   |      |   |          
|Gain on sale of loans and loan servicing, net       |  |                           | 289       |   |      |   | 594      
|Deposit service charges                             |  |                           | 227       |   |      |   | 231      
|Bank-owned life insurance                           |  |                           | 88        |   |      |   | 101      
|Other                                               |  |                           | 855       |   |      |   | 325      
|                                                    |  |                           |           |   |      |   |          
|Total non-interest income                           |  |                           | 1,459     |   |      |   | 1,251    
|                                                    |  |                           |           |   |      |   |          
|Non-interest expense:                               |  |                           |           |   |      |   |          
|Salaries and employee benefits                      |  |                           | 2,443     |   |      |   | 2,133    
|Occupancy                                           |  |                           | 366       |   |      |   | 364      
|Furniture and equipment                             |  |                           | 228       |   |      |   | 203      
|Data processing                                     |  |                           | 252       |   |      |   | 283      
|Professional fees                                   |  |                           | 188       |   |      |   | 176      
|Advertising and promotion                           |  |                           | 86        |   |      |   | 87       
|Other                                               |  |                           | 521       |   |      |   | 563      
|                                                    |  |                           |           |   |      |   |          
|Total non-interest expense                          |  |                           | 4,084     |   |      |   | 3,809    
|                                                    |  |                           |           |   |      |   |          
|Income before income tax expense                    |  |                           | 2,117     |   |      |   | 1,337    
|Income tax expense                                  |  |                           | 640       |   |      |   | 508      
|                                                    |  |                           |           |   |      |   |          
|Net income                                          |  | $                         | 1,477     |   |      | $ | 829      
|                                                    |  |                           |           |   |      |   |          
|Earnings per common share (Note B):                 |  |                           |           |   |      |   |          
|Basic                                               |  | $                         | 1.22      |   |      | $ | 0.69     
|Diluted                                             |  |                           | 1.15      |   |      |   | 0.67     
|                                                    |  |                           |           |   |      |   |          
|Weighted average common shares (Note B):            |  |                           |           |   |      |   |          
|Basic                                               |  | $                         | 1,207,723 |   |      | $ | 1,198,627
|Diluted                                             |  |                           | 1,283,797 |   |      |   | 1,246,126
|                                                    |  |                           |           |   |      |   |          



See accompanying notes to unaudited
consolidated financial statements.



3



---

##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003

(In thousands, except per share data)

(unaudited)



|                                           |  |              |    |                           |   |                   |  |   |                |   |  |                                 |      |   |                                        |   |      |                           |  |   |     |   |  |   |        |  
|------------------------------------------ |  | ------------ | -- | ------------------------- | - | ----------------- |  | - | -------------- | - |  | ------------------------------- | ---- | - | -------------------------------------- | - | ---- | ------------------------- |  | - | --- | - |  | - | ------ | -
|                                           |  | Common Stock |    | Additional Paid-inCapital |   | Retained Earnings |  |   | Treasury Stock |   |  | Unearned Restricted StockAwards |      |   | Accumulated Other Comprehensive Income |   |      | TotalStockholders Equity | 
|Balances at January 1, 2003                |  | $            | 13 |                           | $ | 13,954            |  | $ | 6,205          |   |  | $                               | (749 | ) |                                        | $ | (183 | )                         |  | $ | 98  |   |  | $ | 19,338 |  
|Comprehensive income:                      |  |              |    |                           |   |                   |  |   |                |   |  |                                 |      |   |                                        |   |      |                           |  |   |     |   |  |   |        |  
|Net income                                 |  |              |   |                           |   |                  |  |   | 829            |   |  |                                 |     |   |                                        |   |     |                           |  |   |    |   |  |   | 829    |  
|Other comprehensive loss                   |  |              |   |                           |   |                  |  |   |               |   |  |                                 |     |   |                                        |   |     |                           |  |   | (22 | ) |  |   | (22    | )
|Total comprehensive income                 |  |              |    |                           |   |                   |  |   |                |   |  |                                 |      |   |                                        |   |      |                           |  |   |     |   |  |   | 807    |  
|Cash dividends declared ($0.225 per share) |  |              |   |                           |   |                  |  |   | (275           | ) |  |                                 |     |   |                                        |   |     |                           |  |   |    |   |  |   | (275   | )
|Shares issued in connection with:          |  |              |    |                           |   |                   |  |   |                |   |  |                                 |      |   |                                        |   |      |                           |  |   |     |   |  |   |        |  
|Restricted stock awards                    |  |              |   |                           |   | 65                |  |   |               |   |  |                                 | 106  |   |                                        |   | (171 | )                         |  |   |    |   |  |   |       |  
|Stock option exercises                     |  |              |   |                           |   | 51                |  |   |               |   |  |                                 |     |   |                                        |   |     |                           |  |   |    |   |  |   | 51     |  
|Dividend Reinvestment Plan                 |  |              |   |                           |   | 53                |  |   |               |   |  |                                 |     |   |                                        |   |     |                           |  |   |    |   |  |   | 53     |  
|                                           |  |              |    |                           |   |                   |  |   |                |   |  |                                 |      |   |                                        |   |      |                           |  |   |     |   |  |   |        |  
|Balances at June 30, 2003                  |  |              | 13 |                           |   | 14,123            |  |   | 6,759          |   |  |                                 | (643 | ) |                                        |   | (354 | )                         |  |   | 76  |   |  |   | 19,974 |  
|                                           |  |              |    |                           |   |                   |  |   |                |   |  |                                 |      |   |                                        |   |      |                           |  |   |     |   |  |   |        |  
|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 loss                   |  |              |   |                           |   |                  |  |   |               |   |  |                                 |     |   |                                        |   |     |                           |  |   | (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 |  
|                                           |  |              |    |                           |   |                   |  |   |                |   |  |                                 |      |   |                                        |   |      |                           |  |   |     |   |  |   |        |  



See
accompanying notes to unaudited consolidated financial statements.



4



---

##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003

(In thousands)

(unaudited)



|                                                                                            |  |      |         |   |      |   |         |  
|------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                                                                            |  | 2004 |         |   | 2003 |  
|Operating activities:                                                                       |  |      |         |   |      |   |         |  
|Net income                                                                                  |  | $    | 1,477   |   |      | $ | 829     |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities: |  |      |         |   |      |   |         |  
|Depreciation and amortization                                                               |  |      | 270     |   |      |   | 300     |  
|Provision for loan losses                                                                   |  |      | (550    | ) |      |   | 175     |  
|Originations of loans held for sale                                                         |  |      | (8,032  | ) |      |   | (12,376 | )
|Proceeds from sales of loans held for sale                                                  |  |      | 8,633   |   |      |   | 17,819  |  
|(Increase) decrease in accrued interest receivable                                          |  |      | (61     | ) |      |   | 135     |  
|Increase in other assets                                                                    |  |      | (67     | ) |      |   | (143    | )
|Decrease in accrued interest payable                                                        |  |      | (31     | ) |      |   | (12     | )
|Increase in other liabilities                                                               |  |      | 472     |   |      |   | 425     |  
|Income on bank-owned life insurance                                                         |  |      | (88     | ) |      |   | (101    | )
|Other adjustments, net                                                                      |  |      | (70     | ) |      |   | (14     | )
|                                                                                            |  |      |         |   |      |   |         |  
|Net cash provided by operating activities                                                   |  |      | 1,953   |   |      |   | 7,037   |  
|                                                                                            |  |      |         |   |      |   |         |  
|Investing activities:                                                                       |  |      |         |   |      |   |         |  
|Proceeds from maturities and calls of securities available for sale                         |  |      | 6,788   |   |      |   | 2,669   |  
|Proceeds from maturities and calls of securities held to maturity                           |  |      | 7,224   |   |      |   | 5,610   |  
|Purchases of securities available for sale                                                  |  |      |        |   |      |   | (7,990  | )
|Purchases of securities held to maturity                                                    |  |      | (36,152 | ) |      |   | (2,529  | )
|Net loan (originations) repayments, other than loans held for sale                          |  |      | (9,131  | ) |      |   | 3,959   |  
|Redemption (purchases) of bank-owned life insurance                                         |  |      | 666     |   |      |   | (66     | )
|Purchases of Federal Home Loan Bank stock                                                   |  |      |        |   |      |   | (92     | )
|Purchases of premises and equipment                                                         |  |      | (411    | ) |      |   | (165    | )
|                                                                                            |  |      |         |   |      |   |         |  
|Net cash (used in) provided by investing activities                                         |  |      | (31,016 | ) |      |   | 1,396   |  
|                                                                                            |  |      |         |   |      |   |         |  
|Financing activities:                                                                       |  |      |         |   |      |   |         |  
|Net (decrease) increase in deposits                                                         |  |      | (2,337  | ) |      |   | 21,791  |  
|Net increase in borrowings under securities repurchase agreements                           |  |      | 1,881   |   |      |   | 295     |  
|Dividends paid on common stock                                                              |  |      | (279    | ) |      |   | (273    | )
|Proceeds from issuance of common stock                                                      |  |      | 75      |   |      |   | 104     |  
|                                                                                            |  |      |         |   |      |   |         |  
|Net cash (used in) provided by financing activities                                         |  |      | (660    | ) |      |   | 21,917  |  
|                                                                                            |  |      |         |   |      |   |         |  
|Net (decrease) increase in cash and cash equivalents                                        |  |      | (29,723 | ) |      |   | 30,350  |  
|Cash and cash equivalents at beginning of period                                            |  |      | 62,829  |   |      |   | 34,204  |  
|                                                                                            |  |      |         |   |      |   |         |  
|Cash and cash equivalents at end of year                                                    |  | $    | 33,106  |   |      | $ | 64,554  |  
|                                                                                            |  |      |         |   |      |   |         |  
|Supplemental information:                                                                   |  |      |         |   |      |   |         |  
|Interest payments                                                                           |  | $    | 1,254   |   |      | $ | 1,549   |  
|Income tax payments                                                                         |  |      | 832     |   |      |   | 532     |  
|Increase (decrease) in liability for securities purchased, not yet settled                  |  |      | 3,030   |   |      |   | (2,529  | )



See
accompanying notes to unaudited consolidated financial statements.



5



---

##### 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, 2003. The interim results
of operations for the period ended June 30, 2004 are not necessarily indicative of the results to be expected for the year ending December 31, 2004 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 (net income less dividends on preferred stock, if any) 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 periods ended June 30, 2004 and 2003 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 EPS, net income applicable to common stock equaled net income for
these periods.



6



---

##### Table of Contents

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. 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, |  
|                                                                                                                          |  | 2004                                 |      |   | 2003                      |   |      | 2004 |  |   | 2003  |  
|                                                                                                                          |  | (in thousands except per share data) |     
|Net income, as reported                                                                                                   |  | $                                    | 422  |   |                           | $ | 417  |      |  | $ | 1,477 |   |  | $ | 829  |  
|Add restriced stock expense included in reported net income, net of related tax effects                                   |  |                                      | 24   |   |                           |   | 11   |      |  |   | 50    |   |  |   | 22   |  
|Deduct restricted stock and stock option expense determined under the fair-value-based method, net of related tax effects |  |                                      | (37  | ) |                           |   | (16  | )    |  |   | (100  | ) |  |   | (27  | )
|                                                                                                                          |  |                                      |      |   |                           |   |      |      |  |   |       |   |  |   |      |  
|Pro forma net income                                                                                                      |  |                                      | 409  |   |                           |   | 412  |      |  |   | 1,427 |   |  |   | 824  |  
|                                                                                                                          |  |                                      |      |   |                           |   |      |      |  |   |       |   |  |   |      |  
|Basic earnings per common share:                                                                                          |  |                                      |      |   |                           |   |      |      |  |   |       |   |  |   |      |  
|As reported                                                                                                               |  | $                                    | 0.35 |   |                           | $ | 0.35 |      |  | $ | 1.22  |   |  | $ | 0.69 |  
|Pro forma                                                                                                                 |  |                                      | 0.34 |   |                           |   | 0.34 |      |  |   | 1.18  |   |  |   | 0.69 |  
|                                                                                                                          |  |                                      |      |   |                           |   |      |      |  |   |       |   |  |   |      |  
|Diluted earnings per common share:                                                                                        |  |                                      |      |   |                           |   |      |      |  |   |       |   |  |   |      |  
|As reported                                                                                                               |  | $                                    | 0.33 |   |                           | $ | 0.33 |      |  | $ | 1.15  |   |  | $ | 0.67 |  
|Pro forma                                                                                                                 |  |                                      | 0.32 |   |                           |   | 0.33 |      |  |   | 1.11  |   |  |   | 0.66 |  
|                                                                                                                          |  |                                      |      |   |                           |   |      |      |  |   |       |   |  |   |      |  



7



---

##### Table of Contents

NOTE D  COMPREHENSIVE INCOME (LOSS)



Comprehensive income (loss) includes net income or loss, 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 loss reported in the statements of
stockholders equity for the three months ended June 30, 2004 and 2003 represents the change during those periods in the after-tax net unrealized gain on securities available for sale.



NOTE E  STANDBY LETTERS OF CREDIT



The Company had outstanding letters of credit of $1,221 and $1,338 at June
30, 2004 and December 31, 2003, 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, 2003. The Companys recognized liability for performance standby letters of credit was insignificant at June 30, 2004.



NOTE F  RECENT ACCOUNTING STANDARDS



SAB No. 105, Application of Accounting Principles to Loan Commitments was issued on March 9, 2004, which specifies that servicing assets embedded
in commitments for loans to be held for sale should be recognized only when the servicing asset has been contractually separated from the associated loans by sale of securitization. SAB No. 105 is effective for commitments entered into after March
31, 2004. The adoption of SAB No. 105 will not have a material effect to the Companys consolidated financial statements.



8



---

##### Table of Contents

|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.



FINANCIAL CONDITION



General



Total assets increased to $230,121 at June 30, 2004 from $225,867 at
December 31, 2003, an increase of $4,254 (or 2%). The increase in assets primarily relates to a decrease in cash and cash equivalents, which was partially offset by an increase in total securities and net loans. The decrease in cash and cash
equivalents of $29,723 was attributed to an increase in total securities of $25,054, an increase in net loans (excluding loans held for sale) of $9,207, as well as a decrease in deposits of $2,337.



Loans



The loan portfolio (excluding loans held for sale) increased to $130,598 at June 30, 2004 from $121,476 at December 31,
2003, an increase of $9,122 (or 8%). The increase in total loans primarily resulted from an increase in non-residential, construction and residential real estate loans. The increase was partially offset by a decrease in commercial as well as
consumer and other loans. The increases in non-residential, residential and construction loans primarily reflect new loan originations for the period.



9



---

##### Table of Contents

Major classifications of loans at June 30, 2004 and December 31, 2003 were as follows:



|                              |  |               |         |   |                   |   |         |              |  |   |               |   |  |     |  
|----------------------------- |  | ------------- | ------- | - | ----------------- | - | ------- | ------------ |  | - | ------------- | - |  | --- | -
|                              |  | June 30, 2004 |         |   | December 31, 2003 |   |         | DollarChange |  |   | PercentChange |  
|Loans secured by real estate: |  |               |         |   |                   |   |         |              |  |   |               |   |  |     |  
|Residential                   |  | $             | 38,891  |   |                   | $ | 36,473  |              |  | $ | 2,418         |   |  | 7   | %
|Non-residential               |  |               | 58,422  |   |                   |   | 52,945  |              |  |   | 5,477         |   |  | 10  |  
|Construction                  |  |               | 17,727  |   |                   |   | 14,920  |              |  |   | 2,807         |   |  | 19  |  
|Commercial loans              |  |               | 13,804  |   |                   |   | 15,077  |              |  |   | (1,273        | ) |  | (8  | )
|Consumer and Other Loans      |  |               | 1,811   |   |                   |   | 2,116   |              |  |   | (305          | ) |  | (14 | )
|                              |  |               |         |   |                   |   |         |              |  |   |               |   |  |     |  
|Total Loans                   |  |               | 130,655 |   |                   |   | 121,531 |              |  |   | 9,124         |   |  | 8   |  
|Allowance for loan losses     |  |               | (2,302  | ) |                   |   | (2,387  | )            |  |   | 85            |   |  | (4  | )
|Deferred loan fees, net       |  |               | (57     | ) |                   |   | (55     | )            |  |   | (2            | ) |  | 4   |  
|                              |  |               |         |   |                   |   |         |              |  |   |               |   |  |     |  
|Total loans, net              |  | $             | 128,296 |   |                   | $ | 119,089 |              |  | $ | 9,207         |   |  | 8   | %
|                              |  |               |         |   |                   |   |         |              |  |   |               |   |  |     |  



There were no
residential mortgage loans held for sale at June 30, 2004 compared to $595 at December 31, 2003. Small Business Administration (SBA) loans held for sale at June 30, 2004 and December 31, 2003 were $720 and $184, 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.



10



---

##### Table of Contents

The following table summarizes, by type of loan, the recorded investment in non-performing loans at June
30, 2004 and December 31, 2003. 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, 2004 |       |   | December 31, 2003 |  
|Loans on non-accrual status:                                                                                            |  |               |       |   |                   |   |       |  
|Loans secured by real estate                                                                                            |  | $             | 228   |   |                   | $ | 9     |  
|Commercial loans                                                                                                        |  |               | 112   |   |                   |   |       |  
|Consumer and other loans                                                                                                |  |               | 5     |   |                   |   |      |  
|                                                                                                                        |  |               |       |   |                   |   |       |  
|                                                                                                                        |  |               | 345   |   |                   |   | 9     |  
|                                                                                                                        |  |               |       |   |                   |   |       |  
|Loans on accrual status:                                                                                                |  |               |       |   |                   |   |       |  
|Loans secured by real estate                                                                                            |  |               | 645   |   |                   |   | 777   |  
|Commercial loans                                                                                                        |  |               | 15    |   |                   |   | 91    |  
|Consumer and other loans                                                                                                |  |               | 26    |   |                   |   | 44    |  
|                                                                                                                        |  |               |       |   |                   |   |       |  
|                                                                                                                        |  |               | 686   |   |                   |   | 912   |  
|                                                                                                                        |  |               |       |   |                   |   |       |  
|Total loans past due 90 days or more                                                                                    |  |               | 1,031 |   |                   |   | 921   |  
|                                                                                                                        |  |               |       |   |                   |   |       |  
|Loans current or past due less than 90 days for which interest payments were being applied to reduc principal balances: |  |               |       |   |                   |   |       |  
|Commercial loans                                                                                                        |  |               | 340   |   |                   |   | 218   |  
|                                                                                                                        |  |               |       |   |                   |   |       |  
|                                                                                                                        |  |               | 340   |   |                   |   | 218   |  
|                                                                                                                        |  |               |       |   |                   |   |       |  
|Total non-performing loans                                                                                              |  | $             | 1,371 |   |                   | $ | 1,139 |  
|                                                                                                                        |  |               |       |   |                   |   |       |  
|Ratio of total non-performing loans to total loans outstanding                                                          |  |               | 1.05  | % |                   |   | 0.94  | %
|                                                                                                                        |  |               |       |   |                   |   |       |  



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, |  
|                               |  | 2004                        |       |   | 2003                      |   |       | 2004 |  |   | 2003  |  
|Balance at beginning of period |  | $                           | 2,339 |   |                           | $ | 2,347 |      |  | $ | 2,387 |   |  | $ | 2,234 |  
|Provision for loan losses      |  |                             | (39   | ) |                           |   | 70    |      |  |   | (550  | ) |  |   | 175   |  
|Loan charge-offs               |  |                             | (3    | ) |                           |   | (2    | )    |  |   | (7    | ) |  |   | (2    | )
|Recoveries                     |  |                             | 5     |   |                           |   | 9     |      |  |   | 472   |   |  |   | 17    |  
|                               |  |                             |       |   |                           |   |       |      |  |   |       |   |  |   |       |  
|Balance at end of period       |  | $                           | 2,302 |   |                           | $ | 2,424 |      |  | $ | 2,302 |   |  | $ | 2,424 |  
|                               |  |                             |       |   |                           |   |       |      |  |   |       |   |  |   |       |  



11



---

##### Table of Contents

During the six months ended June 30, 2004 the Bank recovered $690, of which $460 was a recovery of
previously charged-off principal and $216 in interest which was subsequently applied to income. The ratios of the allowance for loan losses to total loans and to non-performing loans were 1.75% and 168% respectively, at June 30, 2004, compared to
1.96% and 210%, respectively, at December 31, 2003.



Securities



Total securities increased to $56,643 at June 30, 2004
from $31,589 at December 31, 2003, an increase of $25,054 (or 79%). The increase in the securities portfolio was primarily due to purchases of $39,182 in securities held to maturity, partially offset by maturities and principal paydowns totaling
$14,012.



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



|                           |  |               |        |                    |   |               |  |                    |        |  |   |       
|-------------------------- |  | ------------- | ------ | ------------------ | - | ------------- |  | ------------------ | ------ |  | - | ------
|                           |  | June 30, 2004 |        | December 31, 2003 
|                           |  | AmortizedCost |        | EstimatedFairValue |   | AmortizedCost |  | EstimatedFairValue
|Available for sale         |  |               |        |                    |   |               |  |                    |        |  |   |       
|U.S. Agency securities     |  | $             | 3,021  |                    | $ | 3,029         |  | $                  | 9,535  |  | $ | 9,578 
|Mortgage-backed securities |  |               | 1,207  |                    |   | 1,190         |  |                    | 1,502  |  |   | 1,501 
|                           |  |               |        |                    |   |               |  |                    |        |  |   |       
|                           |  | $             | 4,228  |                    | $ | 4,219         |  | $                  | 11,037 |  | $ | 11,079
|                           |  |               |        |                    |   |               |  |                    |        |  |   |       
|Held to maturity           |  |               |        |                    |   |               |  |                    |        |  |   |       
|U.S. Agency securities     |  | $             | 44,681 |                    | $ | 44,571        |  | $                  | 15,090 |  | $ | 15,519
|Mortgage-backed securities |  |               | 4,676  |                    |   | 4,707         |  |                    | 2,354  |  |   | 2,413 
|Municipal bonds            |  |               | 2,992  |                    |   | 2,945         |  |                    | 2,991  |  |   | 3,012 
|Other                      |  |               | 75     |                    |   | 75            |  |                    | 75     |  |   | 75    
|                           |  |               |        |                    |   |               |  |                    |        |  |   |       
|                           |  | $             | 52,424 |                    | $ | 52,298        |  | $                  | 20,510 |  | $ | 21,019
|                           |  |               |        |                    |   |               |  |                    |        |  |   |       
|Total                      |  | $             | 56,652 |                    | $ | 56,517        |  | $                  | 31,547 |  | $ | 32,098
|                           |  |               |        |                    |   |               |  |                    |        |  |   |       



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 30,2004 |         | December 31,2003 |   | DollarChange |  |   | PercentChange |  
|Demand (non-interest bearing)          |  | $            | 49,715  |                  | $ | 44,142       |  | $ | 5,573         |   |  | 13  | %
|Money market demand and NOW            |  |              | 42,070  |                  |   | 37,233       |  |   | 4,837         |   |  | 13  |  
|Regular, club and money market savings |  |              | 44,427  |                  |   | 42,171       |  |   | 2,256         |   |  | 5   |  
|Time                                   |  |              | 60,169  |                  |   | 75,172       |  |   | (15,003       | ) |  | (20 | )
|                                       |  |              |         |                  |   |              |  |   |               |   |  |     |  
|Total deposits                         |  | $            | 196,381 |                  | $ | 198,718      |  | $ | (2,337        | ) |  | 1   | %
|                                       |  |              |         |                  |   |              |  |   |               |   |  |     |  



12



---

##### Table of Contents

The decrease in deposits was primarily related to the decrease of approximately $15,003 in time deposits
which was partially offset by an increased in demand, Money market demand and NOW accounts as well as increases in regular, club and money market savings. During the first six months of 2004, decreases in time deposits were primarily attributable to
a decline in 12-17 month $15,200. Certificates of deposit in denominations of $100 or more were $14,357 at June 30, 2004 compared to $18,118 at December 31, 2003, a decrease of $3,761 (or 21%).



Liquidity and Capital Resources



At June 30, 2004, total short-term investments, which are made up of federal
funds sold and securities maturing or callable in one year or less, totaled $54,657. 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, 2004 was 27.21%, compared to 37.29% at December 31, 2003. 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, 2004 was 40.26%, compared to 51.63% at December 31, 2003. The decreases in primary and secondary liquidity ratios in
2004 are primarily a result of the reduction in cash and cash equivalents at June 30, 2004 as compared to December 31, 2003. The effect of the lower level of cash and cash equivalents was partially offset by a reduction in time deposits at June 30,
2004 compared to December 31, 2003. 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 $1,953 for the six months ended June 30, 2004 as compared to $7,037 provided by operating activities for the six months ended June 30, 2003, primarily reflecting a decline in net cash inflows from sales of loans
held for sale in the first six months of 2004 compared to the same period last year. Compared to the first six months of 2003, cash used in investing activities increased $32,412, primarily due to the effect of net securities purchases of $22,140
and to a lesser extent net loan disbursements of $9,131 during the six months ended June 30, 2004 as compared to net securities purchase of $2,240 and net loan receipts of $3,959 during the six months ended June 30, 2003. The decrease in net cash
provided by financing activities of $22,577 for the six months ended June 30, 2004, primarily resulted from a decrease in cash provided by deposits. Cash and cash equivalents decreased $29,723 for the six months ended June 30, 2004, compared to an
increase of $30,350 in the first six months of 2003.



At June
30, 2004, the Company had outstanding loan commitments under unused lines of credit of $16,429 and outstanding letters of credit of $1,221.



At June 30, 2004 and December 31, 2003, the Companys consolidated leverage capital ratio was 9.8% and 9.7%, respectively. At June 30, 2004 and
December 31, 2003, the Companys consolidated Tier 1 risk-based capital ratio was 13.9% and 13.7%, respectively. The Companys consolidated total risk-based capital ratio at June 30, 2004 and December 31, 2003 was 15.2% and 15.0%,
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.



13



---

##### 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 also 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 2003 Annual Report on the Companys 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, 2004 and June 30, 2003



Net Income. Net income was $422 for the three months ended June 30,
2004 compared to $417 for the three months ended June 30, 2003, an increase of $5 (or 1%). Diluted earnings per common share were $0.33 for the three months ended June 30, 2004 and 2003 based on weighted average common shares of 1,290,610 and
1,249,422, respectively. The annualized return on average common stockholders equity was 7.87% and 8.46% for the three months ended June 30, 2004 and 2003, respectively. The annualized return on average assets was 0.77% for the three months
ended June 30, 2004 and 0.73% for the three months ended June 30, 2003.



14



---

##### Table of Contents

The higher net income for the three months ended June 30, 2004 was attributable to a credit provision in
the provision for loan losses primarily as a result of the loan recovery previously mentioned and proceeds from key man life insurance, which was partially offset by an increase in salaries and other employee benefits.



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 $2,086 for the three months
ended June 30, 2004, an increase of $105 (or 5%) from the $1,981 reported for the three months ended June 30, 2003. The average yield on interest-earning assets decreased 16 basis points for the quarter ended June 30, 2004 compared to June 30, 2003,
while the average rate paid on interest-bearing liabilities decreased 51 basis points. Declining interest rates during 2003 continued to impact the yields on the Companys loans and federal funds sold. Interest income on a previously
charged-off loan partially offset the general decline in market rates. These continuing low rates also contributed to the decline in the average rate paid on time certificates of deposit. These changes resulted in a 21 basis point increase in the
net interest margin to 4.08% for the quarter ended June 30, 2004 compared to 3.87% for the quarter ended June 30, 2003.



Interest Income. Average earning assets for the three months ended June 30, 2004 were $207,249 compared to $207,458 for the three months ended June
30, 2003, a decrease of $209. Total interest income, which is a function of the volume of interest-earning assets and their related rates, was $2,662 for the three months ended June 30, 2004 compared to $2,756 for the three months ended June 30,
2003, representing a decrease of $94 (or 3%).



Loans represent
the largest component of interest-earning assets. Interest income on loans was $2,218 for the three months ended June 30, 2004 compared to $2,189 for the three months ended June 30, 2003, an increase of $29 (or 1%). Average loan volume increased
during the quarter ended June 30, 2004 compared to June 30, 2003, but the declining yields on the Companys loan portfolio partially offset the effect on interest income. Average loans outstanding in the three months ended June 30, 2004 were
$127,959 compared to $119,518 during the three months ended June 30, 2003, an increase of $8,441 (or 7%). The average yield on loans declined 38 basis points to 6.97% at June 30, 2004 from 7.35% at June 30, 2003.



Average investments in securities and federal funds sold were $79,290 for the
three months ended June 30, 2004 compared to $87,940 for the three months ended June 30, 2003, a decrease of $8,650 (or 10%). Related income decreased to $444 for the three months ended June 30, 2004 from $567 for the three months ended June 30,
2003, a decrease of $123 (or 22%). Average investments in securities, not including federal funds sold, increased by $3,392 (or 8%) during the three months ended June 30, 2004. Declining interest rates during 2003 continued to impact the yields on
the Companys securities and federal funds sold. The decrease in income from securities was due to a decrease in the average interest rate earned on securities and federal funds sold. Average federal funds sold decreased by $12,042 (or 26%).
Although the average volume of securities increased from year to year, this was more than offset by a decline in interest rates on securities and federal funds as well as the level of federal funds sold.



Interest Expense. Interest expense was $576 for the three months ended
June 30, 2004 compared to $775 for the three months ended June 30, 2003, a decrease of $199 (or 26%). Interest expense is a



15



---

##### Table of Contents

function of the volume of interest-bearing liabilities and their related rates. Average interest-bearing liabilities during the three months ended June 30,
2004 were $153,536 compared to $154,078 during the three months ended June 30, 2003, a decrease of $542. The decrease in the rate paid on interest-bearing liabilities resulted in a decline in the average rate paid on interest bearing liabilities of
51 basis points to 1.51% for the quarter ended June 30, 2004 compared to 2.02% for the quarter ended June 30, 2003.



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 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 $(39) the three months ended June 30, 2004 and $70 for the three months ended June 30, 2003.



At June 30, 2004, the Company had $1,371 of non-performing loans, including
$345 of non-accrual loans and $686 of accruing loans greater than 90 days past due. Loans less than 90 days past due for which interest payments were being applied to reduce principal balances were $340 at June 30, 2004. At December 31, 2003, the
Company had $1,139 of non-performing loans, including $9 of non-accrual loans and $912 of accruing loans greater than 90 days past due. Loans less than 90 days past due for which interest payments were being applied to reduce principal balances were
$218 at December 31, 2003.



Non-interest Income.
Non-interest income was $477 for the three months ended June 30, 2004 compared to $667 for the three months ended June 30, 2003, a decrease of $190 (or 28%). The $216 decrease in the net gain on sale of loans and loan servicing for the three months
ended June 30, 2004 compared to June 30, 2003 relates to the reduced volume of SBA loans originated and sold and to a lesser extent the origination and sale of mortgage loans.



Non-interest Expense. Total non-interest expense was $1,920 for the three months ended June 30, 2004 and $1,900 for
the three months ended June 30, 2003, an increase of $20 (or 1%). The increase in furniture and equipment primarily relates to depreciation on improvements made to the Summer Street office during the three months ended June 30, 2004. The increase in
professional fees for the three months ended June 30, 2004 primarily relates to increased legal and audit fees. These increases were partially offset by a reduction in data processing expense which resulted from savings from a change in the
Banks items processing vendor.



16



---

##### Table of Contents

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



|                               |  |                            |       |                                  |   |          |  |   |          |   |  |     |  
|------------------------------ |  | -------------------------- | ----- | -------------------------------- | - | -------- |  | - | -------- | - |  | --- | -
|                               |  | Three months EndedJune 30, |       | Increase (Decrease) 2004 vs 2003 |  
|Category                       |  | 2004                       |       | 2003                             |   | $ Change |  |   | % Change |  
|Salaries and employee benefits |  | $                          | 1,093 |                                  | $ | 1,030    |  | $ | 63       |   |  | 6   | %
|Occupancy                      |  |                            | 177   |                                  |   | 180      |  |   | (3       | ) |  | (2  | )
|Furniture and equipment        |  |                            | 114   |                                  |   | 101      |  |   | 13       |   |  | 13  |  
|Data processing                |  |                            | 119   |                                  |   | 140      |  |   | (21      | ) |  | (15 | )
|Professional fees              |  |                            | 94    |                                  |   | 83       |  |   | 11       |   |  | 13  |  
|Advertising and promotion      |  |                            | 42    |                                  |   | 41       |  |   | 1        |   |  | 2   |  
|Other                          |  |                            | 281   |                                  |   | 325      |  |   | (44      | ) |  | (14 | )
|                               |  |                            |       |                                  |   |          |  |   |          |   |  |     |  
|Total non-interest expense     |  | $                          | 1,920 |                                  | $ | 1,900    |  | $ | 20       |   |  | 1   | %
|                               |  |                            |       |                                  |   |          |  |   |          |   |  |     |  



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 decreased by $284 (or 8%) in the second quarter of 2004 compared to the same
period in 2003.



|                               |  |       |   |  |       |  
|------------------------------ |  | ----- | - |  | ----- | -
|Category                       |  | 2004  |   |  | 2003  |  
|Salaries and employee benefits |  | 34.82 | % |  | 30.09 | %
|Occupancy                      |  | 5.64  | % |  | 5.26  | %
|Furniture and equipment        |  | 3.63  | % |  | 2.95  | %
|Data processing                |  | 3.79  | % |  | 4.09  | %
|Professional fees              |  | 3.00  | % |  | 2.42  | %
|Advertising and promotion      |  | 1.34  | % |  | 1.20  | %
|Other                          |  | 8.95  | % |  | 9.50  | %
|                               |  |       |   |  |       |  
|Total non-interest expense     |  | 61.17 | % |  | 55.51 | %
|                               |  |       |   |  |       |  



Income Taxes.
The provision for income taxes decreased to $260 for the three months ended June 30, 2004 from $261 for the three months ended June 30, 2003.



Comparative Analysis of Operating Results for the Six Months Ended June 30, 2004 and June 30, 2003



Net Income. Net income was $1,477 for the six months ended June 30, 2004 compared to $829 for the six months ended
June 30, 2003, an increase of $648 (or 78%). Diluted earnings per common share were $1.15 for the six months ended June 30, 2004 and $0.67 for the six months ended June 30, 2003 based on weighted average common shares of 1,283,797 and 1,246,126,
respectively. The annualized return on average common stockholders equity was 14.03% and 8.52% for the six months ended June 30, 2004 and 2003, respectively. The annualized return on average assets was 1.36% for the six months ended June 30,
2004 and 0.75% for the six months ended June 30, 2003.



17



---

##### Table of Contents

The higher net income for the six months ended June 30, 2004 was attributable to a credit provision in
the provision for loan losses primarily as a result of the loan recovery previously mentioned and proceeds from key man life insurance, as well as a decline in interest expense. This was partially offset by a decline in income on securities and
federal funds sold, increases in salaries and other employee benefits as well as an increase in income tax expense.



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 $4,192 for the six months ended June 30, 2004, an increase of $122 (or 3%) from the $4,070 reported
for the six months ended June 30, 2003. The average yield on interest-earning assets decreased 28 basis points for the quarter ended June 30, 2004 compared to June 30, 2003, while the average rate paid on interest-bearing liabilities decreased 47
basis points. Declining interest rates during 2003 continued to impact the yields on the Companys loans and federal funds sold. Interest income on a previously charged-off loan and the increased average volume of interest-earning assets
(primarily loans) partially offset the general decline in market rates. These continuing low rates also contributed to the decline in the average rate paid on time certificates of deposit. These changes resulted in a 5 basis point increase in the
net interest margin to 4.12% for the quarter ended June 30, 2004 compared to 4.07% for the quarter ended June 30, 2003.



Interest Income. Average earning assets for the six months ended June 30, 2004 were $205,474 compared to $202,488 for the six months ended June 30,
2003, an increase of $2,986 (or 1%). Total interest income, which is a function of the volume of interest-earning assets and their related rates, was $5,415 for the six months ended June 30, 2004 compared to $5,607 for the six months ended June 30,
2003, representing a decrease of $192 (or 3%).



Loans represent
the largest component of interest-earning assets. Interest income on loans was $4,556 for the six months ended June 30, 2004 compared to $4,515 for the six months ended June 30, 2003, an increase of $41 (or 1%). Average loan volume increased during
the six months ended June 30, 2004 compared to June 30, 2003, but the declining yields on the Companys loan portfolio almost fully offset the significant effect on interest income. The effect of declining yields was also partially offset by a
recovery of interest on a loan charged-off in December 2000. Average loans outstanding in the six months ended June 30, 2004 were $126,310 compared to $122,280 during the six months ended June 30, 2003, an increase of $4,030 (or 3%). The average
yield on loans decreased 20 basis points to 7.25% for the six months ended June 30, 2004 compare to 7.45% for the six months ended June 30, 2003.



Average investments in securities and federal funds sold were $79,164 for the six months ended June 30, 2004 compared to $80,209 for the six months ended
June 30, 2003, a decrease of $1,045 (or 1%). Related income decreased to $859 for the six months ended June 30, 2004 from $1,092 for the six months ended June 30, 2003, a decrease of $233 (or 21%). Average investments in securities, not including
federal funds sold, increased by $1,003 (or 2%) during the six months ended June 30, 2004. The decrease in income from securities was due to a decrease in the average interest rate earned on securities and federal funds sold. Average federal funds
sold decreased by $2,048 (or 5%). Although the average volume of securities declined from year to year, approximately $31,271 in net purchases (purchases of new securities less maturing securities) were made during the first six months of 2004 to
reduce the level of federal funds.



18



---

##### Table of Contents

Interest Expense. Interest expense was $1,223 for the six months ended June 30, 2004 compared to
$1,537 for the six months ended June 30, 2003, a decrease of $314 (or 20%). 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, 2004 were $152,833 compared to $148,624 during the six months ended June 30, 2003, an increase of $4,209 (or 3%). The decrease in the rate paid on interest-bearing liabilities resulted in a decline in the average rate paid on interest bearing
liabilities of 47 basis points to 1.61% for the quarter ended June 30, 2004 compared to 2.08% for the quarter ended June 30, 2003.



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 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 $(550) the six months ended June 30, 2004 and $175 for the six months ended June 30, 2003. Net loan recoveries were $465 in the six months ended
June 30, 2004 compared to net loan recoveries of $15 in the first six months of last year. Approximately $460 in principal was recovered during the first quarter ending March 31, 2004 on loans to one borrower which were charged-off in December
2000.



At June 30, 2004, the Company had $1,371of
non-performing loans, including $345 of non-accrual loans and $686 of accruing loans greater than 90 days past due. Loans less than 90 days past due for which interest payments were being applied to reduce principal balances were $340 at June 30,
2004. At December 31, 2003, the Company had $1,139 of non-performing loans, including $9 of non-accrual loans and $912 of accruing loans greater than 90 days past due. Loans less than 90 days past due for which interest payments were being applied
to reduce principal balances were $218 at December 31, 2003.



Non-interest Income. Non-interest income was $1,459 for the six months ended June 30, 2004 compared to $1,251 for the six months ended June 30, 2003, an increase of $208 (or 17%). The increase of $530 in other income is directly
attributable to the net proceeds of $495 received by the Bank on a key man life insurance policy on the former Vice Chairman which was partially offset by a $305 decrease in the net gain on sale of loans and loan servicing for the six months ended
June 30, 2004 compared to June 30, 2003. The decline in the gain on sale of loans and loan servicing relates to the reduced volume of SBA and mortgage loans available for sale in 2004 compared to 2003.



19



---

##### Table of Contents

Non-interest Expense. Total non-interest expense was $4,084 for the six months ended June 30, 2004
and $3,809 for the six months ended June 30, 2003, an increase of $275 (or 7%).



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



|                               |  |                          |       |                                 |   |          |  |   |          |   |  |     |  
|------------------------------ |  | ------------------------ | ----- | ------------------------------- | - | -------- |  | - | -------- | - |  | --- | -
|                               |  | Six months EndedJune 30, |       | Increase (Decrease)2004 vs 2003 |  
|Category                       |  | 2004                     |       | 2003                            |   | $ Change |  |   | % Change |  
|Salaries and employee benefits |  | $                        | 2,443 |                                 | $ | 2,133    |  | $ | 310      |   |  | 15  | %
|Occupancy                      |  |                          | 366   |                                 |   | 364      |  |   | 2        |   |  | 1   |  
|Furniture and equipment        |  |                          | 228   |                                 |   | 203      |  |   | 25       |   |  | 12  |  
|Data processing                |  |                          | 252   |                                 |   | 283      |  |   | (31      | ) |  | (11 | )
|Professional fees              |  |                          | 188   |                                 |   | 176      |  |   | 12       |   |  | 7   |  
|Advertising and promotion      |  |                          | 86    |                                 |   | 87       |  |   | (1       | ) |  | 1   |  
|Other                          |  |                          | 521   |                                 |   | 563      |  |   | (42      | ) |  | (7  | )
|                               |  |                          |       |                                 |   |          |  |   |          |   |  |     |  
|Total non-interest expense     |  | $                        | 4,084 |                                 | $ | 3,809    |  | $ | 275      |   |  | 7   | %
|                               |  |                          |       |                                 |   |          |  |   |          |   |  |     |  



The increase in
salaries and employee benefits primarily relates to increased benefit accruals for the retirement and medical benefits of the former Vice Chairman who passed away on January 8, 2004. The increase in furniture and equipment primarily relates to
depreciation on improvements made to the Summer Street office during the three months ended June 30, 2004. The increase in professional fees for the three months ended June 30, 2004 primarily relates to increased legal and audit fees. These
increases were partially offset by a reduction in data processing expense which resulted from savings from a change in the Banks items processing vendor.



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 $16 in the first six months of 2004 compared to the same period in 2003.



|                               |  |                          |   |  |       |  
|------------------------------ |  | ------------------------ | - |  | ----- | -
|                               |  | Six months EndedJune 30, |  
|Category                       |  | 2004                     |   |  | 2003  |  
|Salaries and employee benefits |  | 35.54                    | % |  | 31.03 | %
|Occupancy                      |  | 5.32                     | % |  | 5.30  | %
|Furniture and equipment        |  | 3.32                     | % |  | 2.95  | %
|Data processing                |  | 3.67                     | % |  | 4.12  | %
|Professional fees              |  | 2.73                     | % |  | 2.56  | %
|Advertising and promotion      |  | 1.25                     | % |  | 1.27  | %
|Other                          |  | 7.58                     | % |  | 8.18  | %
|                               |  |                          |   |  |       |  
|Total non-interest expense     |  | 59.41                    | % |  | 55.41 | %
|                               |  |                          |   |  |       |  



Income Taxes.
The provision for income taxes increased to $640 for the six months ended June 30, 2004 from $508 for the six months ended June 30, 2003, primarily due to higher income before income tax expense which was partially offset by a lower effective tax
rate.



20



---

##### Table of Contents

|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, 2004 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, 2004, 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 to
this report.



PART II - Other Information



|Item 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------



The Annual Meeting of Shareholders of the Company was held on May 26, 2004. At the Annual Meeting, the shareholders elected James P. Jakubek, Joseph A.
Maida, Melvin L. Maisel and Paul H. Reader, to the Board of Directors of the Company. There were 957,865 votes for and 3,486 votes withheld for Mr. Jakubek; and 959,593 votes for and 1,758 votes withheld for Mr. Maida; 960,452 votes for and 899
votes withheld for Mr. Maisel, and 959,335 votes for and 2,016 votes withheld for Mr. Reader. All four were elected for terms which expire at the 2007 Annual Meeting of Shareholders. Joseph Field, J. James Gordon, Donald Sappern, Merrill Forgotson
and Courtney A. Nelthropp are currently serving terms on the Board of Directors which expire at the 2005 Annual Meeting of Shareholders. Stanley A. Levine, Leonard Miller, Ronald C. Miller, Martin Prince and Dr. Joseph Waxberg are currently serving
terms on the Board of Directors which expire at the 2006 Annual Meeting of Shareholders.



The shareholders also ratified the appointment by the Board of Directors of KPMG LLP as the Companys independent auditors for the fiscal year ending December 31, 2004. There were 959,081 votes for, 1,998 votes
against and 451 abstentions with respect to such ratification.



21



---

##### Table of Contents

|Item 6. | Exhibits and Reports on Form 8-K
|------- | --------------------------------



(a) 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.



(b) Reports on Form 8-K



The Company filed the following reports on Form 8-K during the quarter ended June 30, 2004:



|1. | Form 8-K filed on April 28, 2004 reporting earnings for the year ended March 31, 2004.
|-- | --------------------------------------------------------------------------------------



|2. | Form 8-K filed on June 17, 2004 reporting cash dividend for second quarter.
|-- | ---------------------------------------------------------------------------



22



---

##### 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 13, 2004 |  |  |  | /s/ Merrill J. Forgotson              
|                      |  |  |  |                                        |  | Merrill J. Forgotson                 
|                      |  |  |  |                                        |  | President and Chief Executive Officer



|                      |  |  |  |                       |  |                                           
|--------------------- |  |  |  | --------------------- |  | ------------------------------------------
|                      |  | 
|Date: August 13, 2004 |  |  |  | /s/ Ernest J. Verrico
|                      |  |  |  |                       |  | Ernest J. Verrico                         
|                      |  |  |  |                       |  | Vice President and Chief Financial Officer



23