##### Table of Contents

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United States Securities and Exchange Commission

Washington, D.C. 20549



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FORM 10-QSB



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(Mark One)

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



For the quarterly period ended September 30, 2005



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



For the transition period from  to



Commission file number: 0-25465



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CORNERSTONE BANCORP, INC./CT

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



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



550 Summer St.,
Stamford, Connecticut 06901

(Address of principal executive offices)



(203) 356-0111

(Issuers telephone number)



---



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 ̈



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



The number of shares outstanding of the issuers common stock as of October 31, 2005
was 1,348,671.



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



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##### Table of Contents

TABLE OF CONTENTS



PART I  Financial Information



|                                                                                                          |  |       
|--------------------------------------------------------------------------------------------------------- |  | ------
|                                                                                                          |  | PAGE  
|Item 1. Financial Statements                                                                              |  |       
|                                                                                                          | 
|Consolidated Statements of Condition September 30, 2005 (unaudited) and
December 31, 2004                 |  | 1     
|                                                                                                          | 
|Consolidated Statements of Income Three Months Ended September 30, 2005 and 2004
(unaudited)              |  | 2     
|                                                                                                          | 
|Consolidated Statements of Income Nine Months Ended September 30, 2005 and 2004
(unaudited)               |  | 3     
|                                                                                                          | 
|Consolidated Statements of Stockholders Equity Nine Months Ended
September 30, 2005 and 2004 (unaudited) |  | 4     
|                                                                                                          | 
|Consolidated Statements of Cash Flows Nine Months Ended September 30, 2005 and 2004
(unaudited)           |  | 5     
|                                                                                                          | 
|Notes to Consolidated Financial Statements (unaudited)                                                    |  | 6 - 9 
|                                                                                                          | 
|Item 2. Managements Discussion and Analysis or Plan of Operation                                         |  | 9 - 22
|                                                                                                          | 
|Item 3. Controls and Procedures                                                                           |  | 22    
|                                                                                                          | 
|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                                               |  | 23    
|                                                                                                          | 
|Item 5. Other Information                                                                                 |  | None  
|                                                                                                          | 
|Item 6. Exhibits                                                                                          |  | 23    
|                                                                                                          | 
|Signatures                                                                                                |  | 24    



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##### Table of Contents

PART 1 - Financial Information



Item 1. Financial Statements.



CORNERSTONE BANCORP, INC. AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF CONDITION



(In
thousands, except per share data)



|                                                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                                                                      |  | September 30,2005 |         |   | December 31,2004 |  
|                                                                                                                                                                                                      |  | (unaudited)       |         |   |                  |  
|Assets                                                                                                                                                                                                |  |                   |         |   |                  |   |         |  
|Cash and cash equivalents:                                                                                                                                                                            |  |                   |         |   |                  |   |         |  
|Cash and due from banks                                                                                                                                                                               |  | $                 | 11,341  |   |                  | $ | 8,205   |  
|Federal funds sold                                                                                                                                                                                    |  |                   | 21,700  |   |                  |   | 9,200   |  
|                                                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|Total cash and cash equivalents                                                                                                                                                                       |  |                   | 33,041  |   |                  |   | 17,405  |  
|                                                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|Securities, including collateral of $7,282 in 2005 and $9,991 in 2004 for borrowings under securities repurchase agreements:                                                                          |  |                   |         |   |                  |   |         |  
|Available for sale, at fair value                                                                                                                                                                     |  |                   | 709     |   |                  |   | 2,962   |  
|Held to maturity, at amortized cost (fair value of $42,337 in 2005 and $47,697 in 2004)                                                                                                               |  |                   | 42,912  |   |                  |   | 47,872  |  
|                                                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|Total securities                                                                                                                                                                                      |  |                   | 43,621  |   |                  |   | 50,834  |  
|                                                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|Loans held for sale                                                                                                                                                                                   |  |                   | 2,269   |   |                  |   | 1,994   |  
|Loans, net of allowance for loan losses of $2,244 at September 30, 2005 and $2,216 at December 31, 2004                                                                                               |  |                   | 130,762 |   |                  |   | 130,617 |  
|Accrued interest receivable                                                                                                                                                                           |  |                   | 1,030   |   |                  |   | 996     |  
|Federal Home Loan Bank stock, at cost                                                                                                                                                                 |  |                   | 667     |   |                  |   | 613     |  
|Premises and equipment                                                                                                                                                                                |  |                   | 2,936   |   |                  |   | 3,207   |  
|Bank-owned life insurance                                                                                                                                                                             |  |                   | 5,013   |   |                  |   | 4,858   |  
|Deferred income taxes                                                                                                                                                                                 |  |                   | 919     |   |                  |   | 990     |  
|Other assets                                                                                                                                                                                          |  |                   | 685     |   |                  |   | 288     |  
|                                                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|Total assets                                                                                                                                                                                          |  | $                 | 220,943 |   |                  | $ | 211,802 |  
|                                                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|Liabilities and Stockholders Equity                                                                                                                                                                  |  |                   |         |   |                  |   |         |  
|Liabilities:                                                                                                                                                                                          |  |                   |         |   |                  |   |         |  
|Deposits:                                                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|Demand (non-interest bearing)                                                                                                                                                                         |  | $                 | 53,166  |   |                  | $ | 42,225  |  
|Money market demand and NOW                                                                                                                                                                           |  |                   | 35,487  |   |                  |   | 39,561  |  
|Regular, club and preferred rate savings                                                                                                                                                              |  |                   | 34,044  |   |                  |   | 42,202  |  
|Time                                                                                                                                                                                                  |  |                   | 63,364  |   |                  |   | 53,139  |  
|                                                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|Total deposits                                                                                                                                                                                        |  |                   | 186,061 |   |                  |   | 177,127 |  
|                                                                                                                                                                                                      |  |                  
|Borrowings under securities repurchase agreements                                                                                                                                                     |  |                   | 7,304   |   |                  |   | 10,060  |  
|Accrued interest payable                                                                                                                                                                              |  |                   | 85      |   |                  |   | 75      |  
|Other liabilities                                                                                                                                                                                     |  |                   | 2,295   |   |                  |   | 1,908   |  
|                                                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|Total liabilities                                                                                                                                                                                     |  |                   | 195,745 |   |                  |   | 189,170 |  
|                                                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|Stockholders equity                                                                                                                                                                                  |  |                   |         |   |                  |   |         |  
|Common stock, par value $0.01 per share. Authorized 5,000,000 shares; issued 1,390,257 shares in 2005 and 1,301,348 shares in 2004;
outstanding 1,348,671 shares in 2005 and 1,259,962 shares in 2004 |  |                   | 14      |   |                  |   | 13      |  
|Additional paid-in capital                                                                                                                                                                            |  |                   | 16,413  |   |                  |   | 14,673  |  
|Retained earnings                                                                                                                                                                                     |  |                   | 9,754   |   |                  |   | 9,117   |  
|Treasury stock, at cost (41,586 shares in 2005 and 41,386 shares in 2004)                                                                                                                             |  |                   | (436    | ) |                  |   | (433    | )
|Unearned restricted stock awards                                                                                                                                                                      |  |                   | (539    | ) |                  |   | (728    | )
|Accumulated other comprehensive loss, net of taxes                                                                                                                                                    |  |                   | (8      | ) |                  |   | (10     | )
|                                                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|Total stockholders equity                                                                                                                                                                            |  |                   | 25,198  |   |                  |   | 22,632  |  
|                                                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|Total liabilities and stockholders equity                                                                                                                                                            |  | $                 | 220,943 |   |                  | $ | 211,802 |  
|                                                                                                                                                                                                      |  |                   |         |   |                  |   |         |  



See
accompanying notes to consolidated financial statements.



1



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##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004

(In thousands, except per share data)

(unaudited)



|                                                    |  |                                 |           |      |   |          
|--------------------------------------------------- |  | ------------------------------- | --------- | ---- | - | ---------
|                                                    |  | Three Months EndedSeptember 30,
|                                                    |  | 2005                            |           | 2004
|Interest income:                                    |  |                                 |           |      |   |          
|Loans                                               |  | $                               | 2,602     |      | $ | 2,329    
|Securities                                          |  |                                 | 359       |      |   | 448      
|Federal funds sold                                  |  |                                 | 160       |      |   | 39       
|                                                    |  |                                 |           |      |   |          
|Total interest income                               |  |                                 | 3,121     |      |   | 2,816    
|                                                    |  |                                 |           |      |   |          
|Interest expense:                                   |  |                                 |           |      |   |          
|Deposits                                            |  |                                 | 644       |      |   | 529      
|Borrowings                                          |  |                                 | 30        |      |   | 31       
|                                                    |  |                                 |           |      |   |          
|Total interest expense                              |  |                                 | 674       |      |   | 560      
|                                                    |  |                                 |           |      |   |          
|Net interest income                                 |  |                                 | 2,447     |      |   | 2,256    
|Provision for loan losses                           |  |                                 | 35        |      |   | 21       
|                                                    |  |                                 |           |      |   |          
|Net interest income after provision for loan losses |  |                                 | 2,412     |      |   | 2,235    
|                                                    |  |                                 |           |      |   |          
|Non-interest income:                                |  |                                 |           |      |   |          
|Gain on sale of loans and loan servicing, net       |  |                                 | 141       |      |   | 294      
|Deposit service charges                             |  |                                 | 92        |      |   | 120      
|Bank-owned life insurance                           |  |                                 | 43        |      |   | 46       
|Other                                               |  |                                 | 224       |      |   | 184      
|                                                    |  |                                 |           |      |   |          
|Total non-interest income                           |  |                                 | 500       |      |   | 644      
|                                                    |  |                                 |           |      |   |          
|Non-interest expense:                               |  |                                 |           |      |   |          
|Salaries and employee benefits                      |  |                                 | 1,247     |      |   | 1,129    
|Occupancy                                           |  |                                 | 209       |      |   | 181      
|Furniture and equipment                             |  |                                 | 109       |      |   | 113      
|Data processing                                     |  |                                 | 126       |      |   | 113      
|Professional fees                                   |  |                                 | 217       |      |   | 102      
|Advertising and promotion                           |  |                                 | 31        |      |   | 57       
|Other                                               |  |                                 | 280       |      |   | 293      
|                                                    |  |                                 |           |      |   |          
|Total non-interest expense                          |  |                                 | 2,219     |      |   | 1,988    
|                                                    |  |                                 |           |      |   |          
|Income before income tax expense                    |  |                                 | 693       |      |   | 891      
|Income tax expense                                  |  |                                 | 290       |      |   | 355      
|                                                    |  |                                 |           |      |   |          
|Net income                                          |  | $                               | 403       |      | $ | 536      
|                                                    |  |                                 |           |      |   |          
|Earnings per common share (Note B):                 |  |                                 |           |      |   |          
|Basic                                               |  | $                               | 0.31      |      | $ | 0.44     
|Diluted                                             |  |                                 | 0.30      |      |   | 0.42     
|                                                    |  |                                 |           |      |   |          
|Weighted average common shares (Note B):            |  |                                 |           |      |   |          
|Basic                                               |  |                                 | 1,228,820 |      |   | 1,214,379
|Diluted                                             |  |                                 | 1,339,884 |      |   | 1,289,047
|                                                    |  |                                 |           |      |   |          



See
accompanying notes to consolidated financial statements.



2



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##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF INCOME



FOR THE
NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004



(In
thousands, except per share data)



(unaudited)



|                                                    |  |                                |           |      |   |           |  
|--------------------------------------------------- |  | ------------------------------ | --------- | ---- | - | --------- | -
|                                                    |  | Nine Months EndedSeptember 30, |          
|                                                    |  | 2005                           |           | 2004 |  
|Interest income:                                    |  |                                |           |      |   |           |  
|Loans                                               |  | $                              | 7,721     |      | $ | 6,885     |  
|Securities                                          |  |                                | 1,155     |      |   | 1,142     |  
|Federal funds sold                                  |  |                                | 292       |      |   | 205       |  
|                                                    |  |                                |           |      |   |           |  
|Total interest income                               |  |                                | 9,168     |      |   | 8,232     |  
|                                                    |  |                                |           |      |   |           |  
|Interest expense:                                   |  |                                |           |      |   |           |  
|Deposits                                            |  |                                | 1,785     |      |   | 1,720     |  
|Borrowings                                          |  |                                | 139       |      |   | 63        |  
|                                                    |  |                                |           |      |   |           |  
|Total interest expense                              |  |                                | 1,924     |      |   | 1,783     |  
|                                                    |  |                                |           |      |   |           |  
|Net interest income                                 |  |                                | 7,244     |      |   | 6,449     |  
|                                                    |  |                               
|Provision for (recovery of) loan losses             |  |                                | 137       |      |   | (529      | )
|                                                    |  |                                |           |      |   |           |  
|Net interest income after provision for loan losses |  |                                | 7,107     |      |   | 6,978     |  
|                                                    |  |                                |           |      |   |           |  
|Non-interest income:                                |  |                                |           |      |   |           |  
|Gain on sale of loans and loan servicing, net       |  |                                | 312       |      |   | 583       |  
|Deposit service charges                             |  |                                | 293       |      |   | 347       |  
|Bank-owned life insurance                           |  |                                | 129       |      |   | 133       |  
|Other                                               |  |                                | 628       |      |   | 1,039     |  
|                                                    |  |                                |           |      |   |           |  
|Total non-interest income                           |  |                                | 1,362     |      |   | 2,102     |  
|                                                    |  |                                |           |      |   |           |  
|Non-interest expense:                               |  |                                |           |      |   |           |  
|Salaries and employee benefits                      |  |                                | 3,633     |      |   | 3,571     |  
|Occupancy                                           |  |                                | 645       |      |   | 546       |  
|Furniture and equipment                             |  |                                | 327       |      |   | 341       |  
|Data processing                                     |  |                                | 383       |      |   | 365       |  
|Professional fees                                   |  |                                | 634       |      |   | 291       |  
|Advertising and promotion                           |  |                                | 121       |      |   | 144       |  
|Other                                               |  |                                | 817       |      |   | 814       |  
|                                                    |  |                                |           |      |   |           |  
|Total non-interest expense                          |  |                                | 6,560     |      |   | 6,072     |  
|                                                    |  |                                |           |      |   |           |  
|Income before income tax expense                    |  |                                | 1,909     |      |   | 3,008     |  
|                                                    |  |                               
|Income tax expense                                  |  |                                | 831       |      |   | 995       |  
|                                                    |  |                                |           |      |   |           |  
|Net income                                          |  | $                              | 1,078     |      | $ | 2,013     |  
|                                                    |  |                                |           |      |   |           |  
|Earnings per common share (Note B):                 |  |                                |           |      |   |           |  
|Basic                                               |  | $                              | 0.86      |      | $ | 1.66      |  
|Diluted                                             |  |                                | 0.82      |      |   | 1.50      |  
|                                                    |  |                                |           |      |   |           |  
|Weighted average common shares (Note B):            |  |                                |           |      |   |           |  
|Basic                                               |  |                                | 1,255,986 |      |   | 1,210,183 |  
|Diluted                                             |  |                                | 1,321,400 |      |   | 1,342,711 |  
|                                                    |  |                                |           |      |   |           |  



See
accompanying notes to consolidated financial statements.



3



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##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY



FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004



(In thousands, except per share data)



(unaudited)



|                                            |  |             |    |                          |   |                  |  |   |               |   |  |                               |      |   |                                            |   |      |                          |  |   |     |   |  |   |        |  
|------------------------------------------- |  | ----------- | -- | ------------------------ | - | ---------------- |  | - | ------------- | - |  | ----------------------------- | ---- | - | ------------------------------------------ | - | ---- | ------------------------ |  | - | --- | - |  | - | ------ | -
|                                            |  | CommonStock |    | AdditionalPaid-inCapital |   | RetainedEarnings |  |   | TreasuryStock |   |  | UnearnedRestrictedStockAwards |      |   | AccumulatedOtherComprehensiveIncome (Loss) |   |      | TotalStockholdersEquity | 
|Balances at January 1, 2004                 |  | $           | 13 |                          | $ | 14,298           |  | $ | 7,253         |   |  | $                             | (545 | ) |                                            | $ | (558 | )                        |  | $ | 26  |   |  | $ | 20,487 |  
|                                            |  |             |    |                          |   |                  | 
|Comprehensive income:                       |  |             |    |                          |   |                  |  |   |               |   |  |                               |      |   |                                            |   |      |                          |  |   |     |   |  |   |        |  
|Net income                                  |  |             |   |                          |   |                 |  |   | 2,013         |   |  |                               |     |   |                                            |   |     |                          |  |   |    |   |  |   | 2,013  |  
|Other comprehensive income (note D)         |  |             |   |                          |   |                 |  |   |              |   |  |                               |     |   |                                            |   |     |                          |  |   | (26 | ) |  |   | (26    | )
|                                            |  |             |    |                          |   |                  | 
|Total comprehensive income                  |  |             |    |                          |   |                  |  |   |               |   |  |                               |      |   |                                            |   |      |                          |  |   |     |   |  |   | 1,987  |  
|                                            |  |             |    |                          |   |                  | 
|Cash dividends declared ($0.3375 per share) |  |             |   |                          |   |                 |  |   | (422          | ) |  |                               |     |   |                                            |   |     |                          |  |   |    |   |  |   | (422   | )
|                                            |  |             |    |                          |   |                  | 
|Shares issued in connection with:           |  |             |    |                          |   |                  |  |   |               |   |  |                               |      |   |                                            |   |      |                          |  |   |     |   |  |   |        |  
|Restricted stock awards                     |  |             |   |                          |   | 138              |  |   |              |   |  |                               | 112  |   |                                            |   | (170 | )                        |  |   |    |   |  |   | 80     |  
|Stock Option Exercises                      |  |             |    |                          |   | 71               |  |   |              |   |  |                               |     |   |                                            |   |     |                          |  |   |    |   |  |   | 71     |  
|Dividend Reinvestment Plan                  |  |             |   |                          |   | 83               |  |   |              |   |  |                               |     |   |                                            |   |     |                          |  |   |    |   |  |   | 83     |  
|                                            |  |             |    |                          |   |                  |  |   |               |   |  |                               |      |   |                                            |   |      |                          |  |   |     |   |  |   |        |  
|Balances at September 30, 2004              |  |             | 13 |                          |   | 14,590           |  |   | 8,844         |   |  |                               | (433 | ) |                                            |   | (728 | )                        |  |   |    |   |  |   | 22,286 |  
|                                            |  |             |    |                          |   |                  |  |   |               |   |  |                               |      |   |                                            |   |      |                          |  |   |     |   |  |   |        |  
|Balances at January 1, 2005                 |  | $           | 13 |                          | $ | 14,673           |  | $ | 9,117         |   |  | $                             | (433 | ) |                                            | $ | (728 | )                        |  | $ | (10 | ) |  | $ | 22,632 |  
|                                            |  |             |    |                          |   |                  | 
|Comprehensive income:                       |  |             |    |                          |   |                  |  |   |               |   |  |                               |      |   |                                            |   |      |                          |  |   |     |   |  |   |        |  
|Net income                                  |  |             |   |                          |   |                  |  |   | 1,078         |   |  |                               |     |   |                                            |   |     |                          |  |   |    |   |  |   | 1,078  |  
|Other comprehensive income (note D)         |  |             |   |                          |   |                 |  |   |              |   |  |                               |     |   |                                            |   |     |                          |  |   | 2   |   |  |   | 2      |  
|                                            |  |             |    |                          |   |                  | 
|Total comprehensive income                  |  |             |    |                          |   |                  |  |   |               |   |  |                               |      |   |                                            |   |      |                          |  |   |     |   |  |   | 1,080  |  
|                                            |  |             |    |                          |   |                  | 
|Cash dividends declared ($0.3375 per share) |  |             |   |                          |   |                 |  |   | (441          | ) |  |                               |     |   |                                            |   |     |                          |  |   |    |   |  |   | (441   | )
|                                            |  |             |    |                          |   |                  | 
|Shares issued in connection with:           |  |             |    |                          |   |                  |  |   |               |   |  |                               |      |   |                                            |   |      |                          |  |   |     |   |  |   |        |  
|Restricted stock awards                     |  |             |   |                          |   | 49               |  |   |              |   |  |                               | (3   | ) |                                            |   | 189  |                          |  |   |    |   |  |   | 235    |  
|Stock option exercises                      |  |             | 1  |                          |   | 1,627            |  |   |              |   |  |                               |     |   |                                            |   |     |                          |  |   |    |   |  |   | 1,628  |  
|Dividend Reinvestment Plan                  |  |             |   |                          |   | 64               |  |   |              |   |  |                               |     |   |                                            |   |     |                          |  |   |    |   |  |   | 64     |  
|                                            |  |             |    |                          |   |                  |  |   |               |   |  |                               |      |   |                                            |   |      |                          |  |   |     |   |  |   |        |  
|Balances at September 30, 2005              |  |             | 14 |                          |   | 16,413           |  |   | 9,754         |   |  |                               | (436 | ) |                                            |   | (539 | )                        |  |   | (8  | ) |  |   | 25,198 |  
|                                            |  |             |    |                          |   |                  |  |   |               |   |  |                               |      |   |                                            |   |      |                          |  |   |     |   |  |   |        |  



See
accompanying notes to unaudited consolidated financial statements.



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##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004

(In thousands)

(unaudited)



|                                                                                  |  |      |        |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------- | -
|                                                                                  |  | 2005 |        |   | 2004 |  
|Operating activities:                                                             |  |      |        |   |      |   |         |  
|Net income                                                                        |  | $    | 1,078  |   |      | $ | 2,013   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |        |   |      |   |         |  
|Depreciation and amortization                                                     |  |      | 289    |   |      |   | 385     |  
|Provision for (recovery of) loan losses                                           |  |      | 137    |   |      |   | (529    | )
|Originations of loans held for sale                                               |  |      | (7,026 | ) |      |   | (12,399 | )
|Proceeds from sales of loans held for sale                                        |  |      | 7,063  |   |      |   | 12,971  |  
|Increase in accrued interest receivable                                           |  |      | (34    | ) |      |   | (171    | )
|(Increase) decrease in other assets                                               |  |      | (397   | ) |      |   | 33      |  
|Increase (decrease) in accrued interest payable                                   |  |      | 10     |   |      |   | (33     | )
|Increase in other liabilities                                                     |  |      | 387    |   |      |   | 796     |  
|Income on bank-owned life insurance                                               |  |      | (129   | ) |      |   | (133    | )
|Other adjustments, net                                                            |  |      | 629    |   |      |   | 176     |  
|                                                                                  |  |      |        |   |      |   |         |  
|Net cash provided by operating activities                                         |  |      | 2,007  |   |      |   | 3,109   |  
|                                                                                  |  |      |        |   |      |   |         |  
|Investing activities:                                                             |  |      |        |   |      |   |         |  
|Proceeds from maturities and calls of securities available for sale               |  |      | 2,242  |   |      |   | 6,918   |  
|Proceeds from maturities and calls of securities held to maturity                 |  |      | 4,971  |   |      |   | 10,552  |  
|Purchases of securities held to maturity                                          |  |      |       |   |      |   | (39,178 | )
|Net loan originations, other than loans held for sale                             |  |      | (188   | ) |      |   | (13,725 | )
|(Purchases) redemption of bank-owned life insurance                               |  |      | (26    | ) |      |   | 665     |  
|Purchases of Federal Home Loan Bank stock                                         |  |      | (54    | ) |      |   |        |  
|Purchases of premises and equipment                                               |  |      | (18    | ) |      |   | (431    | )
|                                                                                  |  |      |        |   |      |   |         |  
|Net cash provided by (used in) investing activities                               |  |      | 6,927  |   |      |   | (35,199 | )
|                                                                                  |  |      |        |   |      |   |         |  
|Financing activities:                                                             |  |      |        |   |      |   |         |  
|Net increase (decrease) in deposits                                               |  |      | 8,934  |   |      |   | (19,189 | )
|Net (decrease) increase in borrowings under securities repurchase agreements      |  |      | (2,756 | ) |      |   | 5,142   |  
|Net increase in borrowings from the Federal Home Loan Bank                        |  |      |       |   |      |   | 5,000   |  
|Dividends paid on common stock                                                    |  |      | (431   | ) |      |   | (422    | )
|Proceeds from issuance of common stock                                            |  |      | 955    |   |      |   | 154     |  
|                                                                                  |  |      |        |   |      |   |         |  
|Net cash provided by (used in) financing activities                               |  |      | 6,702  |   |      |   | (9,315  | )
|                                                                                  |  |      |        |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                              |  |      | 15,636 |   |      |   | (41,405 | )
|                                                                                  |  |     
|Cash and cash equivalents at beginning of year                                    |  |      | 17,405 |   |      |   | 62,829  |  
|                                                                                  |  |      |        |   |      |   |         |  
|Cash and cash equivalents at end of year                                          |  | $    | 33,041 |   |      | $ | 21,424  |  
|                                                                                  |  |      |        |   |      |   |         |  
|Supplemental information:                                                         |  |      |        |   |      |   |         |  
|Interest payments                                                                 |  | $    | 1,914  |   |      | $ | 1,858   |  
|Income tax payments                                                               |  |      | 630    |   |      |   | 902     |  



See
accompanying notes to consolidated financial statements.



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##### Table of Contents

CORNERSTONE BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (UNAUDITED)

(dollars in thousands)



NOTE A - BASIS OF FINANCIAL STATEMENT PRESENTATION



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



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



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



NOTE B - EARNINGS PER SHARE



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



NOTE C  STOCK-BASED COMPENSATION



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



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##### Table of Contents

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



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



|                                                                                                                          |  |                                      |      |   |                                      |   |      |      |  |   |       |   |  |   |       |  
|------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------ | ---- | - | ------------------------------------ | - | ---- | ---- |  | - | ----- | - |  | - | ----- | -
|                                                                                                                          |  | Three Months Ended September 30,     |      |   | Nine Months EndedSeptember 30,       |  
|                                                                                                                          |  | 2005                                 |      |   | 2004                                 |   |      | 2005 |  |   | 2004  |  
|                                                                                                                          |  | (in thousands except per share data) |      |   | (in thousands except per share data) |  
|Net income, as reported                                                                                                   |  | $                                    | 403  |   |                                      | $ | 536  |      |  | $ | 1,078 |   |  | $ | 2,013 |  
|Add restricted stock expense included in reported net income, net of related tax effects                                  |  |                                      | 23   |   |                                      |   | 22   |      |  |   | 67    |   |  |   | 72    |  
|                                                                                                                          |  |                                      |      |  
|Deduct restricted stock and stock option expense determined under the fair-value-based method, net of related tax effects |  |                                      | (23  | ) |                                      |   | (34  | )    |  |   | (67   | ) |  |   | (134  | )
|                                                                                                                          |  |                                      |      |   |                                      |   |      |      |  |   |       |   |  |   |       |  
|Pro forma net income                                                                                                      |  |                                      | 403  |   |                                      |   | 524  |      |  |   | 1,078 |   |  |   | 1,951 |  
|                                                                                                                          |  |                                      |      |   |                                      |   |      |      |  |   |       |   |  |   |       |  
|Basic earnings per common share:                                                                                          |  |                                      |      |   |                                      |   |      |      |  |   |       |   |  |   |       |  
|As reported                                                                                                               |  | $                                    | 0.31 |   |                                      | $ | 0.44 |      |  | $ | 0.86  |   |  | $ | 1.66  |  
|Pro forma                                                                                                                 |  |                                      | 0.31 |   |                                      |   | 0.43 |      |  |   | 0.86  |   |  |   | 1.61  |  
|                                                                                                                          |  |                                      |      |   |                                      |   |      |      |  |   |       |   |  |   |       |  
|Diluted earnings per common share:                                                                                        |  |                                      |      |   |                                      |   |      |      |  |   |       |   |  |   |       |  
|As reported                                                                                                               |  | $                                    | 0.30 |   |                                      | $ | 0.42 |      |  | $ | 0.82  |   |  | $ | 1.50  |  
|Pro forma                                                                                                                 |  |                                      | 0.30 |   |                                      |   | 0.41 |      |  |   | 0.82  |   |  |   | 1.45  |  
|                                                                                                                          |  |                                      |      |   |                                      |   |      |      |  |   |       |   |  |   |       |  



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NOTE D  COMPREHENSIVE INCOME (LOSS)



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



NOTE E  STANDBY LETTERS OF CREDIT



The Company had outstanding letters of credit of $327 at September 30, 2005 and $1,216 at December 31, 2004, respectively. Substantially all of
the Companys outstanding standby letters of credit are performance standby letters of credit within the scope of FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (FIN 45). These are irrevocable undertakings by the Company, as guarantor, to make payments in the event a specified third party fails to perform under a non-financial contractual obligation. Most
of the Companys performance standby letters of credit arise in connection with lending relationships and have terms of one year or less. The maximum potential future payments the Company could be required to make equals the contract amount of
the standby letters of credit referred to above. FIN 45 also requires the recognition, at fair value, of a liability by a guarantor at the inception of certain guarantees issued or modified after December 31, 2004. The Companys recognized
liability for performance standby letters of credit was insignificant at September 30, 2005.



NOTE F  RECENT ACCOUNTING STANDARDS



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



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



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



NOTE G  MERGER



The shareholders of Cornerstone Bancorp, at its annual meeting held on August 10, 2005, approved the Agreement and Plan of Merger dated as of
April 12, 2005 (the Merger Agreement) by and among Cornerstone Bancorp, Inc. (CBI), NewAlliance Bancshares, Inc. (NAL) and their wholly-owned subsidiaries, Cornerstone Bank and NewAlliance Bank. Subject to
the terms of the Merger Agreement, CBI will merge with and into NAL (the Merger) and immediately thereafter, Cornerstone Bank will merge with and into NewAlliance Bank.



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

(dollars in thousands)



FORWARD-LOOKING STATEMENTS



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



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



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##### Table of Contents

FINANCIAL CONDITION



General



Total assets increased to $220,943 at September 30, 2005 from $211,802 at December 31, 2004, an increase of $9,141 (or 4%). The increase in assets primarily relates to an increase in total cash and cash
equivalents. This was partially offset by a decrease in total securities. The increase in cash and cash equivalents of $15,636 was attributable to an increase in deposits of $8,934, and proceeds of $7,213 from the maturity of securities held to
maturity and securities available for sale.



Loans



The loan portfolio (excluding loans held for sale) increased to $133,006
at September 30, 2005 from $132,833 at December 31, 2004, an increase of $173. The increase in total loans primarily resulted from an increase in construction loans and to a lesser extent from commercial loans. The increase was largely
offset by a decrease in residential loans, and to a lesser extent from a decrease in non-residential and consumer and other loans. The increase in construction loans primarily reflects new loan originations and customer advances during the period
ended September 30, 2005. The increase in commercial loans was primarily due to the origination of new loans during the period ended September 30, 2005. The decrease in residential loans as well as non-residential and consumer and other
loans, was primarily due to payoff activity exceeding new loan originations for the period ended September 30, 2005.



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



|                              |  |                    |         |   |                   |   |         |              |  |   |               |   |  |     |   
|----------------------------- |  | ------------------ | ------- | - | ----------------- | - | ------- | ------------ |  | - | ------------- | - |  | --- | --
|                              |  | September 30, 2005 |         |   | December 31, 2004 |   |         | DollarChange |  |   | PercentChange |  
|Loans secured by real estate: |  |                    |         |   |                   |   |         |              |  |   |               |   |  |     |   
|Residential                   |  | $                  | 30,813  |   |                   | $ | 39,489  |              |  | $ | (8,676        | ) |  | (22 | )%
|Non-residential               |  |                    | 56,357  |   |                   |   | 56,606  |              |  |   | (249          | ) |  |    |   
|Construction                  |  |                    | 29,844  |   |                   |   | 21,733  |              |  |   | 8,111         |   |  | 37  |   
|Commercial loans              |  |                    | 14,536  |   |                   |   | 13,536  |              |  |   | 1,000         |   |  | 7   |   
|Consumer and Other Loans      |  |                    | 1,503   |   |                   |   | 1,621   |              |  |   | (118          | ) |  | (7  | ) 
|                              |  |                    |         |   |                   |   |         |              |  |   |               |   |  |     |   
|Total Loans                   |  |                    | 133,053 |   |                   |   | 132,985 |              |  |   | 68            |   |  |    |   
|                              |  |                    |         |  
|Allowance for loan losses     |  |                    | (2,244  | ) |                   |   | (2,216  | )            |  |   | (28           | ) |  | 1   |   
|Deferred loan fees, net       |  |                    | (47     | ) |                   |   | (152    | )            |  |   | 105           |   |  | (69 | ) 
|                              |  |                    |         |   |                   |   |         |              |  |   |               |   |  |     |   
|Total loans, net              |  | $                  | 130,762 |   |                   | $ | 130,617 |              |  | $ | 145           |   |  |    | % 
|                              |  |                    |         |   |                   |   |         |              |  |   |               |   |  |     |   



Small Business
Administration (SBA) loans held for sale at September 30, 2005 and December 31, 2004 were $2,269 and $1,994, respectively.



Non-performing Loans and the Allowance for Loan Losses



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



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##### Table of Contents

The following table summarizes, by type of loan, the recorded investment in non-performing loans at
September 30, 2005 and December 31, 2004. Amounts are shown for (i) loans that were past due 90 days or more, segregated between those on non-accrual status and those that were still accruing interest, and (ii) loans that were
current or past due less than 90 days for which interest payments were being applied to reduce principal balances. During the nine months ended September 2005, $297 in real estate loans on accrual status at December 31, 2004 were paid-off.
These loans were replaced by a loan to one borrower which was past due greater than 90 days at September 30, 2005. The increase in commercial loans current or past due less than 90 days for which interest payments were being applied to reduce
principal balances was due to the addition of one loan to one borrower during the period ended September 2005.



|                                                                                                                         |  |                    |       |   |                   |   |      |  
|------------------------------------------------------------------------------------------------------------------------ |  | ------------------ | ----- | - | ----------------- | - | ---- | -
|                                                                                                                         |  | September 30, 2005 |       |   | December 31, 2004 |  
|Loans past due 90 days or more                                                                                           |  |                    |       |   |                   |   |      |  
|Loans on non-accrual status:                                                                                             |  |                    |       |   |                   |   |      |  
|Loans secured by real estate                                                                                             |  | $                  | 196   |   |                   | $ | 167  |  
|Commercial loans                                                                                                         |  |                    | 36    |   |                   |   | 87   |  
|Consumer and other loans                                                                                                 |  |                    |      |   |                   |   | 30   |  
|                                                                                                                         |  |                    |       |   |                   |   |      |  
|                                                                                                                         |  |                    | 232   |   |                   |   | 284  |  
|                                                                                                                         |  |                    |       |   |                   |   |      |  
|Loans on accrual status:                                                                                                 |  |                    |       |   |                   |   |      |  
|Loans secured by real estate                                                                                             |  |                    | 675   |   |                   |   | 321  |  
|Commercial loans                                                                                                         |  |                    | 29    |   |                   |   |     |  
|Consumer and other loans                                                                                                 |  |                    | 1     |   |                   |   | 8    |  
|                                                                                                                         |  |                    |       |   |                   |   |      |  
|                                                                                                                         |  |                    | 705   |   |                   |   | 329  |  
|                                                                                                                         |  |                    |       |   |                   |   |      |  
|Total loans past due 90 days or more                                                                                     |  |                    | 937   |   |                   |   | 613  |  
|                                                                                                                         |  |                    |       |   |                   |   |      |  
|Loans current or past due less than 90 days for which interest payments were being applied to reduce principal balances: |  |                    |       |   |                   |   |      |  
|Loans secured by real estate                                                                                             |  |                    | 22    |   |                   |   | 173  |  
|Commercial loans                                                                                                         |  |                    | 284   |   |                   |   | 124  |  
|Consumer and other loans                                                                                                 |  |                    |      |   |                   |   | 5    |  
|                                                                                                                         |  |                    |       |   |                   |   |      |  
|                                                                                                                         |  |                    | 306   |   |                   |   | 302  |  
|                                                                                                                         |  |                    |       |   |                   |   |      |  
|Total non-performing loans                                                                                               |  | $                  | 1,243 |   |                   | $ | 915  |  
|                                                                                                                         |  |                    |       |   |                   |   |      |  
|Ratio of total non-performing loans to total loans outstanding                                                           |  |                    | 0.93  | % |                   |   | 0.69 | %
|                                                                                                                         |  |                    |       |   |                   |   |      |  



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



|                               |  |                                 |       |   |                                |   |       |      |  |   |       |   |  |   |       |  
|------------------------------ |  | ------------------------------- | ----- | - | ------------------------------ | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                               |  | Three Months EndedSeptember 30, |       |   | Nine Months EndedSeptember 30, |  
|                               |  | 2005                            |       |   | 2004                           |   |       | 2005 |  |   | 2004  |  
|Balance at beginning of period |  | $                               | 2,268 |   |                                | $ | 2,302 |      |  | $ | 2,216 |   |  | $ | 2,387 |  
|Provision for loan losses      |  |                                 | 35    |   |                                |   | 21    |      |  |   | 137   |   |  |   | (529  | )
|Loan charge-offs               |  |                                 | (68   | ) |                                |   | (72   | )    |  |   | (120  | ) |  |   | (79   | )
|Recoveries                     |  |                                 | 9     |   |                                |   | 0     |      |  |   | 11    |   |  |   | 472   |  
|                               |  |                                 |       |   |                                |   |       |      |  |   |       |   |  |   |       |  
|Balance at end of period       |  | $                               | 2,244 |   |                                | $ | 2,251 |      |  | $ | 2,244 |   |  | $ | 2,251 |  
|                               |  |                                 |       |   |                                |   |       |      |  |   |       |   |  |   |       |  



During the nine months
ended September 30, 2004, the Bank recovered $690, of which $460 was a recovery of previously charged-off principal on loans to one borrower, and $216 was a recovery of interest that was subsequently applied to income. The ratios of the
allowance for loan losses to total loans and to non-performing loans were 1.66% and 181% respectively, at September 30, 2005, compared to 1.66% and 242%, respectively, at December 31, 2004.



Securities



Total securities decreased to $43,621 at September 30, 2005 from $50,834 at December 31, 2004, a decrease of
$7,213 (or 14%). The decrease in the securities portfolio was primarily due to maturities in the available for sale and held to maturity portfolios during the period ended September 30, 2005, the proceeds of which were held as cash and cash
equivalents.



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##### Table of Contents

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



|                           |  |                    |        |                     |   |               |  |                     |        |  |   |       
|-------------------------- |  | ------------------ | ------ | ------------------- | - | ------------- |  | ------------------- | ------ |  | - | ------
|                           |  | September 30, 2005 |        | December 31, 2004  
|                           |  | AmortizedCost      |        | EstimatedFair Value |   | AmortizedCost |  | EstimatedFair Value
|Available for sale         |  |                    |        |                     |   |               |  |                     |        |  |   |       
|U.S. Agency securities     |  | $                  |       |                     | $ |              |  | $                   | 2,007  |  | $ | 2,004 
|Mortgage-backed securities |  |                    | 722    |                     |   | 709           |  |                     | 970    |  |   | 958   
|                           |  |                    |        |                     |   |               |  |                     |        |  |   |       
|                           |  | $                  | 722    |                     | $ | 709           |  | $                   | 2,977  |  | $ | 2,962 
|                           |  |                    |        |                     |   |               |  |                     |        |  |   |       
|Held to maturity           |  |                    |        |                     |   |               |  |                     |        |  |   |       
|U.S. Agency securities     |  | $                  | 36,707 |                     | $ | 36,178        |  | $                   | 40,688 |  | $ | 40,476
|Mortgage-backed securities |  |                    | 3,137  |                     |   | 3,130         |  |                     | 4,117  |  |   | 4,143 
|Municipal bonds            |  |                    | 2,993  |                     |   | 2,954         |  |                     | 2,992  |  |   | 3,003 
|Other                      |  |                    | 75     |                     |   | 75            |  |                     | 75     |  |   | 75    
|                           |  |                    |        |                     |   |               |  |                     |        |  |   |       
|                           |  | $                  | 42,912 |                     | $ | 42,337        |  | $                   | 47,872 |  | $ | 47,697
|                           |  |                    |        |                     |   |               |  |                     |        |  |   |       
|Total                      |  | $                  | 43,634 |                     | $ | 43,046        |  | $                   | 50,849 |  | $ | 50,659
|                           |  |                    |        |                     |   |               |  |                     |        |  |   |       



Deposits



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



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



|                                       |  |                   |         |                  |   |              |  |   |               |   |  |     |  
|-------------------------------------- |  | ----------------- | ------- | ---------------- | - | ------------ |  | - | ------------- | - |  | --- | -
|                                       |  | September 30,2005 |         | December 31,2004 |   | DollarChange |  |   | PercentChange |  
|Demand (non-interest bearing)          |  | $                 | 53,166  |                  | $ | 42,225       |  | $ | 10,941        |   |  | 26  | %
|Money market demand and NOW            |  |                   | 35,487  |                  |   | 39,561       |  |   | (4,074        | ) |  | (10 | )
|Regular, club and money market savings |  |                   | 34,044  |                  |   | 42,202       |  |   | (8,158        | ) |  | (19 | )
|Time                                   |  |                   | 63,364  |                  |   | 53,139       |  |   | 10,225        |   |  | 19  |  
|                                       |  |                   |         |                  |   |              |  |   |               |   |  |     |  
|Total deposits                         |  | $                 | 186,061 |                  | $ | 177,127      |  | $ | 8,934         |   |  | 5   | %
|                                       |  |                   |         |                  |   |              |  |   |               |   |  |     |  



The increase in
deposits was primarily related to the increase of approximately $10,941 (or 26%) in demand deposits and $10,225 (or 19%) in time deposits. This was partially offset by a decrease in regular, club and money market savings of $8,158 (or 19%), as well
as in money market demand and NOW of $4,074 (or 10%). The increase in demand accounts is primarily attributable to balances maintained in internal Bank checking accounts which are used to fund the payment of incoming official checks resulting from
customer-related activity. The decrease in money market demand and NOW accounts was primarily



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##### Table of Contents

attributable to activity on attorney-related NOW accounts. This was partially offset by higher balances maintained in money market demand accounts during the
period ended September 30, 2005. The decrease in regular, club and money market savings was due to a decline in customer balances. The increase in time deposits was primarily attributable to increases of $12,701 in 12-17 month certificates,
$3,301 in 36-47 month time deposits, $1,466 in 24-30 month time deposits and $413 in 18-23 month time deposits. This was partially offset by decreases of $2,649 in 48-59 month time deposits, $2,561 in 91-180 day time deposits and $2,145 in 181-364
day time deposits. Certificates of deposit in denominations of $100 or more were $16,347 at September 30, 2005 as compared to $12,741 at December 31, 2004, an increase of $3,606 (or 28%).



Liquidity and Capital Resources



At September 30, 2005, total short-term investments, which are made up
of federal funds sold and securities maturing or callable in one year or less, totaled $47,609. 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 September 30, 2005 was 20.37%, compared to 20.04% at December 31, 2004. The Bank also calculates a secondary liquidity ratio which contemplates loan sales and loan payoffs anticipated to occur
within one year and the maturity of available and held to maturity securities beyond one year. The Banks secondary liquidity ratio at September 30, 2005 was 32.73%, compared to 33.38% at December 31, 2004. The Companys internal
guideline is to generally maintain a primary liquidity ratio of 10 to 15% and a secondary liquidity ratio of 20% or more, although a higher primary ratio may be maintained from time to time depending on cash flow patterns and loan demand.



Net cash provided by operating activities was $2,007 for the
nine months ended September 30, 2005 as compared to $3,109 for the nine months ended September 30, 2004, primarily due to a decrease in net income for the period ended September 2005 compared to September 2004. Net cash provided by
investing activities was $6,927 for the nine months ended September 30, 2005 as compared to $35,199 in net cash used in investing activities for the first nine months of 2004. The decrease in cash used in investing activities of $42,126 was
primarily due to the absence of purchases in the held-to-maturity investment portfolio in the first nine months of 2005 as compared to purchases of $39,178 in the first nine months of 2004. The decline in net loan originations (other than loans held
for sale) of $13,537 also contributed to the decrease in cash used in investing activities during the first nine months of 2005 compared to the same period in 2004. These decreases were partially offset by a decrease of $10,257 in proceeds from
maturities and calls of securities available for sale and held to maturity during the first nine months of 2005 compared to the first nine months of 2004. The increase in net cash provided by financing activities of $16,017 for the nine months ended
September 30, 2005 primarily resulted from an increase of $28,123 in cash provided by customers deposits. Cash and cash equivalents increased $15,636 for the nine months ended September 30, 2005 compared to a decrease of $41,405 for
the nine months ended September 30, 2004.



At
September 30, 2005, the Company had outstanding loan commitments under unused lines of credit of $23,782 and outstanding letters of credit of $328.



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##### Table of Contents

At September 30, 2005 and December 31, 2004, the Companys consolidated leverage capital
ratio was 11.5% and 10.2%, respectively. At September 30, 2005 and December 31, 2004, the Companys consolidated Tier 1 risk-based capital ratio was 15.6% and 14.2%, respectively. The Companys consolidated total risk-based
capital ratio at September 30, 2005 and December 31, 2004 was 16.9% and 15.5%, respectively. The Banks regulatory capital ratios at these dates were substantially the same as the consolidated ratios, and the Bank was classified as a
well-capitalized institution for regulatory purposes.



RESULTS OF OPERATIONS



General



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



Critical Accounting Policies



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



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



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##### Table of Contents

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



Net Income. Net income was $403 for the three
months ended September 30, 2005 compared to $536 for the three months ended September 30, 2004, a decrease of $133 (or 25%). Diluted earnings per common share were $0.30 and 0.42 for the three months ended September 30, 2005 and 2004,
respectively, based on weighted average common shares of 1,339,884 and 1,289,047, respectively. The annualized return on average common stockholders equity was 6.47% and 9.83% for the three months ended September 30, 2005 and 2004,
respectively. The annualized return on average assets was 0.73% for the three months ended September 30, 2005 and 0.97% for the three months ended September 30, 2004.



The lower net income for the three months ended September 30, 2005 was primarily due to the decrease of $144 (or 22%)
in non-interest income from the gain on sale of loans and loan servicing, an increase of $118 (or 10%) in salaries and employee benefits as well as increased interest expense of $114 (or 20%). This was partially offset by an increase in loan income
of $273 (or 12%) for the three months ended September 30, 2005.



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



Net interest income was $2,447 for the three months ended September 30, 2005, an increase of $191 (or 8%) from the $2,256 reported for the three
months ended September 30, 2004. The average yield on interest-earning assets increased 62 basis points for the quarter ended September 30, 2005 compared to September 30, 2004, while the average rate paid on interest-bearing
liabilities increased 35 basis points. The higher net interest income for the three months ended September 30, 2005 was primarily due to the growth in the loan portfolio as well as the higher level of interest rates. Total interest income
increased as earning assets were shifted into higher yielding loans. These changes resulted in a 39 basis point increase in the net interest margin to 4.88% for the quarter ended September 30, 2005 compared to 4.49% for the quarter ended
September 30, 2004.



Interest Income.
Average earning assets for the three months ended September 30, 2005 were $200,085 compared to $201,203 for the three months ended September 30, 2004, a decrease of $1,118 (or 1%). Total interest income, which is a function of the volume
of interest-earning assets and their related rates, was $3,121 for the three months ended September 30, 2005 compared to $2,816 for the three months ended September 30, 2004, representing an increase of $305 (or 11%), primarily due to
higher interest rates.



Loans represent the largest component
of interest-earning assets. Interest income on loans was $2,602 for the three months ended September 30, 2005 compared to $2,329 for the three months ended September 30, 2004, an increase of $273 (or 12%). Average loans outstanding in the
three months ended September 30, 2005 were $136,350 compared to $134,154 during the three months ended September 30, 2004, an increase of $2,196 (or 2%). The average yield on loans increased 66 basis point to 7.57% at September 30,
2005 from 6.91% at September 30, 2004 primarily due to the higher level of interest rates in 2005.



Average investments in securities and federal funds sold were $63,735 for the three months ended



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##### Table of Contents

September 30, 2005 compared to $67,049 for the three months ended September 30, 2004, a decrease of $3,314 (or 5%). Related income decreased to
$519 for the three months ended September 30, 2005 from $487 for the three months ended September 30, 2004, a decrease of $32 (or 7%). Average investments in securities, not including federal funds sold, decreased by $10,399 (or 19%)
during the three months ended September 30, 2005. Average federal funds sold increased by $7,085 (or 61%). The increase in federal funds sold was due to an increase in deposits and a decrease in securities.



Interest Expense. Interest expense was $674 for the three months ended
September 30, 2005 compared to $560 for the three months ended September 30, 2004, an increase of $114 (or 20%). Interest expense is a function of the volume of interest-bearing liabilities and their related rates. Average interest-bearing
liabilities during the three months ended September 30, 2005 were $143,844 compared to $147,573 during the three months ended September 30, 2004, a decrease of $3,729 or (3%). The average rate paid on interest-bearing liabilities increased
35 basis points to 1.86% for the quarter ended September 30, 2005 compared to 1.51% for the quarter ended September 30, 2004.



Provision for Loan Losses. The periodic provision for loan losses represents the amount necessary to adjust the allowance for loan losses to
managements estimate of probable credit losses inherent in the existing loan portfolio at the reporting date. Managements determination of the allowance for loan losses is based on the results of continuing reviews of individual loans
and borrower relationships, particularly in the commercial and commercial real estate loan portfolios. A review of the quality of the loan portfolio is conducted internally by management on a quarterly basis, using a consistently-applied
methodology, and the results are presented to the Board of Directors for approval. The evaluation covers individual borrowers whose aggregate loans are greater than $100, as well as all adversely-classified loans. Management also 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 $35 for the three months ended September 30, 2005 and $21 for the three months ended September 30, 2004.



Non-interest Income. Non-interest income was $500 for the three months
ended September 30, 2005 compared to $644 for the three months ended September 30, 2004, a decrease of $144 (or 22%). The decrease in non-interest income was primarily attributable to a decrease of $153 in the net gain on sale of loans and
loan servicing (and to a lesser extent to the origination and sale of mortgage loans) for the three months ended September 30, 2005 as compared to three months ended September 30, 2004.



Non-interest Expense. Total non-interest expense was $2,219 for the
three months ended September 30, 2005 and $1,988 for the three months ended September 30, 2004, an increase of $231 (or 12%). The increase in salaries and employee benefits results from an increase in salaries and bonuses for the three
months ended September 30, 2005 compared to September 30, 2004. The increase in professional fees primarily relates to increased legal and audit fees as well as $55 in merger-related expenses recorded in the quarter ending
September 30, 2005.



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##### 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 EndedSeptember 30, |       | Increase (Decrease)2005 vs 2004 |  
|Category                       |  | 2005                            |       | 2004                            |   | $ Change |  |   | % Change |  
|Salaries and employee benefits |  | $                               | 1,247 |                                 | $ | 1,129    |  | $ | 118      |   |  | 10  | %
|Occupancy                      |  |                                 | 209   |                                 |   | 181      |  |   | 28       |   |  | 15  |  
|Furniture and equipment        |  |                                 | 109   |                                 |   | 113      |  |   | (4       | ) |  | (4  | )
|Data processing                |  |                                 | 126   |                                 |   | 113      |  |   | 13       |   |  | 12  |  
|Professional fees              |  |                                 | 217   |                                 |   | 102      |  |   | 115      |   |  | 113 |  
|Advertising and promotion      |  |                                 | 31    |                                 |   | 57       |  |   | (26      | ) |  | (46 | )
|Other                          |  |                                 | 280   |                                 |   | 293      |  |   | (13      | ) |  | (4  | )
|                               |  |                                 |       |                                 |   |          |  |   |          |   |  |     |  
|Total non-interest expense     |  | $                               | 2,219 |                                 | $ | 1,988    |  | $ | 231      |   |  | 12  | %
|                               |  |                                 |       |                                 |   |          |  |   |          |   |  |     |  



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 $161 (or 5%) in the third quarter of 2005 compared to the same
period in 2004.



|                               |  |                                  |   |  |       |  
|------------------------------ |  | -------------------------------- | - |  | ----- | -
|                               |  | Three months Ended September 30, |  
|Category                       |  | 2005                             |   |  | 2004  |  
|Salaries and employee benefits |  | 34.44                            | % |  | 32.63 | %
|Occupancy                      |  | 5.77                             |   |  | 5.23  |  
|Furniture and equipment        |  | 3.01                             |   |  | 3.27  |  
|Data processing                |  | 3.48                             |   |  | 3.27  |  
|Professional fees              |  | 5.99                             |   |  | 2.95  |  
|Advertising and promotion      |  | 0.86                             |   |  | 1.65  |  
|Other                          |  | 7.73                             |   |  | 8.47  |  
|                               |  |                                  |   |  |       |  
|Total non-interest expense     |  | 61.28                            | % |  | 57.47 | %
|                               |  |                                  |   |  |       |  



Income Taxes.
The provision for income taxes decreased to $290 for the three months ended September 30, 2005 from $355 for the three months ended September 30, 2004, a decrease of $65 (or 18%), primarily due to the lower income before income tax
expense.



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##### Table of Contents

Comparative Analysis of Operating Results for the Nine Months Ended September 30, 2005 and September 30,
2004



Net Income. Net income was $1,078 for the
nine months ended September 30, 2005 compared to $2,013 for the nine months ended September 30, 2004, a decrease of $935 (or 46%). Diluted earnings per common share were $0.82 and $1.50 for the nine months ended September 30, 2005 and
2004, respectively, based on weighted average common shares of 1,321,400 and 1,342,711, respectively. The annualized return on average common stockholders equity was 6.06% and 12.60% for the nine months ended September 30, 2005 and 2004,
respectively. The annualized return on average assets was 0.67% for the nine months ended September 30, 2005 and 1.23% for the nine months ended September 30, 2004.



The lower net income for the nine months ended September 30, 2005 was primarily due to a one-time recovery of $460 on a
previously charged-off loan and $495 in one-time life insurance proceeds received during the nine month period ended September 30, 2004. This was partially offset by the increase in interest income from loans, an increase of $836 (or 12%) and a
decrease of $164 (or 16%) in the provision for income taxes for the nine month period ended September 30, 2005. These increases were partially offset by merger related costs of $290 as well as a decrease of $271 (or 46%) in non-interest income
from the sale of loans and loan servicing for the period ended September 30, 2005.



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



Net interest income was $7,244 for the nine months ended September 30, 2005, an increase of $795 (or 12%) from the $6,449 reported for the nine
months ended September 30, 2004. The average yield on interest-earning assets increased 74 basis points for the nine months ended September 30, 2005 compared to the September 30, 2004 period, while the average rate paid on
interest-bearing liabilities increased 18 basis points. The higher net interest income for the nine months ended September 30, 2005 was primarily due to the growth in the loan portfolio and higher interest rates. Total interest income increased
as earning assets were shifted into higher yielding loans during 2005. These changes resulted in a 62 basis point increase in the net interest margin to 4.92% for the nine months ended September 30, 2005 compared to 4.30% for the nine months
ended September 30, 2004.



Interest Income.
Average earning assets for the nine months ended September 30, 2005 were $198,299 compared to $201,282 for the nine months ended September 30, 2004, a decrease of $2,983 (or 1%). Total interest income, which is a function of the volume of
interest-earning assets and their related rates, was $9,168 for the nine months ended September 30, 2005 compared to $8,232 for the nine months ended September 30, 2004, representing an increase of $936 (or 11%).



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##### Table of Contents

Loans represent the largest component of interest-earning assets. Interest income on loans was $7,721 for
the nine months ended September 30, 2005 compared to $6,885 for the nine months ended September 30, 2004, an increase of $836 (or 12%). Average loans outstanding in the nine months ended September 30, 2005 were $137,841 compared to
$129,149 during the nine months ended September 30, 2004, an increase of $8,692 (or 7%). The average yield on loans increased 37 basis points to 7.49% at September 30, 2005 from 7.11% at September 30, 2004.



Average investments in securities and federal funds sold were $60,458 for the
nine months ended September 30, 2005 compared to $72,133 for the nine months ended September 30, 2004, a decrease of $11,675 (or 16%). Related income increased to $1,447 for the nine months ended September 30, 2005 from $1,347 for the
nine months ended September 30, 2004, an increase of $100 (or 7%). Average investments in securities, not including federal funds sold, increased by $3,037 (or 7%) during the nine months ended September 30, 2005. Average federal funds sold
decreased by $14,712 (or 53%). The increase in the level of interest rates in 2005 contributed to an increase in related income on federal funds sold which was partially offset by a decline in the volume of federal funds sold.



Interest Expense. Interest expense was $1,924 for the nine months
ended September 30, 2005 compared to $1,783 for the nine months ended September 30, 2004, an increase of $141 (or 8%). Interest expense is a function of the volume of interest-bearing liabilities and their related rates. Average
interest-bearing liabilities during the nine months ended September 30, 2005 were $146,133 compared to $150,799 during the nine months ended September 30, 2004, a decrease of $4,666 or (3%). The average rate paid on interest-bearing
liabilities increased 18 basis points to 1.76% for the quarter ended September 30, 2005 compared to 1.58% for the quarter ended September 30, 2004.



Provision for Loan Losses. The periodic provision for loan losses represents the amount necessary to adjust the allowance for loan losses to
managements estimate of probable credit losses inherent in the existing loan portfolio at the reporting date. Managements determination of the allowance for loan losses is based on the results of continuing reviews of individual loans
and borrower relationships, particularly in the commercial and commercial real estate loan portfolios. A review of the quality of the loan portfolio is conducted internally by management on a quarterly basis, using a consistently-applied
methodology, and the results are presented to the Board of Directors for approval. The evaluation covers individual borrowers whose aggregate loans are greater than $100, as well as all adversely-classified loans. Management also 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 $137 for the nine months ended September 30, 2005 and ($529) for the nine months ended September 30, 2004. Approximately $460 in
principal was recovered during the nine months ended September 30, 2004 on loans to one borrower which were charged-off in December 2000.



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##### Table of Contents

Non-interest Income. Non-interest income was $1,362 for the nine months ended September 30,
2005 compared to $2,102 for the nine months ended September 30, 2004, a decrease of $740 (or 35%). This decrease was primarily attributable to the net proceeds of $495 received by the Bank on a key man life insurance policy on the former Vice
Chairman during the period ended September 30, 2004. The decline in non-interest income was also attributable to a decrease of $271 in the net gain on sale of loans and loan servicing for the nine months ended September 30, 2005 due to the
reduced activity as compared to the nine months ended September 30, 2004.



Non-interest Expense. Total non-interest expense was $6,560 for the nine months ended September 30, 2005 and $6,072 for the nine months ended September 30, 2004, an increase of $488 (or 8%). The
increase in total non-interest expense primarily relates to $290 in Merger-related expenses recorded during the nine months ended September 30, 2005 as well as additional occupancy expenses related to the Norwalk branch and increased rental
expense at five offices.



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



|                               |  |                                |       |                                 |   |          |  |   |          |   |  |     |   
|------------------------------ |  | ------------------------------ | ----- | ------------------------------- | - | -------- |  | - | -------- | - |  | --- | --
|                               |  | Nine months EndedSeptember 30, |       | Increase (Decrease)2005 vs 2004 |  
|Category                       |  | 2005                           |       | 2004                            |   | $ Change |  |   | % Change |  
|Salaries and employee benefits |  | $                              | 3,633 |                                 | $ | 3,571    |  | $ | 62       |   |  | (2  | )%
|Occupancy                      |  |                                | 645   |                                 |   | 546      |  |   | 99       |   |  | 18  |   
|Furniture and equipment        |  |                                | 327   |                                 |   | 341      |  |   | (14      | ) |  | (4  | ) 
|Data processing                |  |                                | 383   |                                 |   | 365      |  |   | 18       |   |  | 5   |   
|Professional fees              |  |                                | 634   |                                 |   | 291      |  |   | 343      |   |  | 118 |   
|Advertising and promotion      |  |                                | 121   |                                 |   | 144      |  |   | (23      | ) |  | (16 | ) 
|Other                          |  |                                | 817   |                                 |   | 814      |  |   | 3        |   |  |    |   
|                               |  |                                |       |                                 |   |          |  |   |          |   |  |     |   
|Total non-interest expense     |  | $                              | 6,560 |                                 | $ | 6,072    |  | $ | 488      |   |  | 8   | % 
|                               |  |                                |       |                                 |   |          |  |   |          |   |  |     |   



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##### Table of Contents

The following table summarizes dollar amounts for each category of non-interest expense as a percentage
of total operating income (interest income plus non-interest income). Operating income increased by $196 (or 2%) in the nine month period ended September 30, 2005 compared to the same period in 2004.



|                               |  |                                |   |  |       |  
|------------------------------ |  | ------------------------------ | - |  | ----- | -
|                               |  | Nine months EndedSeptember 30, |  
|Category                       |  | 2005                           |   |  | 2004  |  
|Salaries and employee benefits |  | 34.50                          | % |  | 34.56 | %
|Occupancy                      |  | 6.13                           |   |  | 5.28  |  
|Furniture and equipment        |  | 3.11                           |   |  | 3.30  |  
|Data processing                |  | 3.64                           |   |  | 3.53  |  
|Professional fees              |  | 6.02                           |   |  | 2.82  |  
|Advertising and promotion      |  | 1.15                           |   |  | 1.39  |  
|Other                          |  | 7.75                           |   |  | 7.88  |  
|                               |  |                                |   |  |       |  
|Total non-interest expense     |  | 62.30                          | % |  | 58.76 | %
|                               |  |                                |   |  |       |  



Income Taxes.
The provision for income taxes decreased to $831 for the nine months ended September 30, 2005 from $995 for the nine months ended September 30, 2004, a decrease of $164 (or 16%), primarily due to lower income before income tax expense.



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



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



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



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##### Table of Contents

PART II - Other Information



Item 4. Submission of matters to a Vote of Security Holders.



The Annual Meeting of Shareholders of the Company was held on August 10, 2005. At the Annual Meeting, the shareholders elected Joseph F. Field, Merrill J.
Forgotson, J. James Gordon, Courtney A. Nelthropp and Donald Sappern, Directors of the Company. There were 1,056,513 votes for and 16,694 votes withheld for Mr. Field; 1,066,737 votes for and 6,470 votes withheld for Mr. Forgotson; 989,959 votes for
and 83,248 votes withheld for Mr. Gordon; 1,056,513 votes for and 16,694 votes withheld for Mr. Nelthropp; and 1,056,513 votes for and 16,694 votes withheld for Donald Sappern. All five were elected for terms which expire at the 2008 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. James P. Jakubek, Joseph A.
Maida and Paul H. Reader are currently serving terms on the Board of Directors which expire at the 2007 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, 2005. There were 1,067,721 votes for, 2,771 votes against and 2,715 abstentions with respect to such ratification.



Item 6. Exhibits.



Exhibits:



31.1-Rule 13a-14(a)/15d-14(a) Certification of Merrill J. Forgotson.



31.2-Rule 13a-14(a)/15d-14(a) Certification of Ernest J. Verrico.



32.1-Section 1350 Certifications.



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##### Table of Contents

SIGNATURES



In accordance with
the requirements of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                        |  |                                           
|----------------------- |  | ------------------------------------------
|                        |  | CORNERSTONE BANCORP, INC. (Registrant)    
|                        | 
|Date: November 14, 2005 |  | /s/ Merrill J. Forgotson                  
|                        |  | Merrill J. Forgotson                      
|                        |  | President and Chief Executive Officer     
|                        | 
|Date: November 14, 2005 |  | /s/ Ernest J. Verrico                     
|                        |  | Ernest J. Verrico                         
|                        |  | Vice President and Chief Financial Officer



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