U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________.
Commission File No. 333-63769
COMMUNITY SHORES BANK CORPORATION
(Exact name of small business issuer as specified in its charter)
Michigan 38-3423227
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1030 W. NORTON AVENUE, MUSKEGON, MICHIGAN 49441
(Address of principal executive offices)
(231) 780-1800
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act 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
----- -----
At July 31, 2005, 1,434,800 shares of Common Stock of the issuer were
outstanding.
Transitional Small Business Disclosure Format:
Yes No X
----- -----
Community Shores Bank Corporation Index
Page No.
--------
PART I. Financial Information
Item 1. Financial Statements................................ 1
Item 2. Management's Discussion and Analysis ............... 13
Item 3. Controls and Procedures............................. 24
PART II. Other Information
Item 1. Legal Proceedings................................... 25
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds............................................ 25
Item 3. Defaults upon Senior Securities..................... 25
Item 4. Submission of Matters to a Vote of Security
Holders............................................. 25
Item 5. Other Information................................... 26
Item 6. Exhibits ........................................... 26
Signatures.................................................. 28
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
June 30, December 31,
2005 2004
------------ ------------
(unaudited)
ASSETS
Cash and due from financial institutions $ 6,644,959 $ 2,214,088
Interest-bearing deposits in other financial institutions 278,224 161,527
Federal funds sold 6,650,000 0
------------ ------------
Cash and cash equivalents 13,573,183 2,375,615
Securities
Available for sale (at fair value) 15,274,110 16,530,818
Held to maturity (fair value of $3,354,372 at June 30, 2005 and
$409,023 at December 31, 2005) 3,359,398 399,523
------------ ------------
Total securities 18,633,508 16,930,341
Loans held for sale 130,000 0
Loans 186,726,712 171,451,202
Less: Allowance for loan losses 2,154,519 2,039,198
------------ ------------
Net loans 184,572,193 169,412,004
Federal Home Loan Bank stock 425,000 425,000
Premises and equipment, net 3,561,778 2,542,997
Accrued interest receivable 840,040 734,707
Other assets 1,015,031 1,081,944
------------ ------------
Total assets $222,750,733 $193,502,608
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Non-interest bearing $ 18,062,244 $ 13,153,038
Interest bearing 173,489,212 145,667,485
------------ ------------
Total deposits 191,551,456 158,820,523
Federal funds purchased and repurchase agreements 5,775,131 9,980,778
Federal Home Loan Bank advances 6,000,000 6,000,000
Subordinated debentures 4,500,000 4,500,000
Accrued expenses and other liabilities 867,441 801,975
------------ ------------
Total liabilities 208,694,028 180,103,276
Shareholders' equity
Preferred stock, no par value 1,000,000
Shares authorized, none issued 0 0
Common stock, no par value; 9,000,000 shares authorized; June
30, 2005 1,432,800 & 2004-1,430,000 shares issued 12,950,998 12,922,314
Retained Earnings 1,204,435 499,781
Accumulated other comprehensive loss (98,728) (22,763)
------------ ------------
Total shareholders' equity 14,056,705 13,399,332
------------ ------------
Total liabilities and shareholders' equity $222,750,733 $193,502,608
============ ============
See accompanying notes to consolidated financial statements.
-1-
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004
-------------- ------------- ------------- -------------
Interest and dividend income
Loans, including fees $3,098,902 $2,317,827 $5,921,243 $4,601,650
Securities and FHLB dividends 172,933 126,590 330,717 300,307
Federal funds sold and other income 2,243 11,507 17,272 25,294
---------- ---------- ---------- ----------
Total interest income 3,274,078 2,455,924 6,269,232 4,927,251
Interest expense
Deposits 1,055,047 809,318 1,911,376 1,626,311
Repurchase agreements, federal funds purchased,
and other debt 71,904 26,128 128,453 54,298
Federal Home Loan Bank advances and notes payable 145,357 123,306 283,108 243,841
---------- ---------- ---------- ----------
Total interest expense 1,272,308 958,752 2,322,937 1,924,450
---------- ---------- ---------- ----------
NET INTEREST INCOME 2,001,770 1,497,172 3,946,295 3,002,801
Provision for loan losses 130,335 158,397 247,757 215,274
---------- ---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,871,435 1,338,775 3,698,538 2,787,527
Noninterest income
Service charges on deposit accounts 225,667 167,290 433,503 327,219
Mortgage loan referral fees 0 15,449 2,120 35,579
Net gain on sale of loans 2,724 9,303 16,435 14,588
Net gain (loss) on disposition of securities 0 10,923 0 (6,600)
Other 82,244 69,090 153,216 119,988
---------- ---------- ---------- ----------
Total noninterest income 310,635 272,055 605,274 490,774
Noninterest expense
Salaries and employee benefits 902,709 789,410 1,749,499 1,570,950
Occupancy 72,122 74,559 148,398 154,650
Furniture and equipment 95,880 90,542 179,547 182,450
Advertising 40,320 12,688 86,427 39,181
Data processing 91,178 79,769 178,738 156,148
Professional services 133,327 92,186 265,309 213,130
Other 332,799 232,729 628,645 471,625
---------- ---------- ---------- ----------
Total noninterest expense 1,668,335 1,371,883 3,236,563 2,788,134
---------- ---------- ---------- ----------
INCOME BEFORE FEDERAL INCOME TAXES 513,735 238,947 1,067,249 490,167
Federal income tax expense/(benefit) 171,222 84,631 362,597 166,802
---------- ---------- ---------- ----------
NET INCOME $ 342,513 $ 154,316 $ 704,652 $ 323,365
========== ========== ========== ==========
Comprehensive income (loss) $ 416,458 $ (136,630) $ 628,687 $ 129,660
========== ========== ========== ==========
Weighted average shares outstanding 1,432,800 1,430,000 1,432,057 1,430,000
========== ========== ========== ==========
Diluted average shares outstanding 1,462,813 1,467,309 1,461,141 1,447,594
========== ========== ========== ==========
Basic earnings per share $ 0.24 $ 0.11 $ 0.49 $ 0.23
========== ========== ========== ==========
Diluted earnings per share $ 0.23 $ 0.11 $ 0.48 $ 0.22
========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
-2-
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
Accumulated
Other Total
Common Retained Comprehensive Shareholders'
Shares Stock Earnings Income (Loss) Equity
--------- ----------- ---------- ------------- -------------
BALANCE AT JANUARY 1, 2004 1,430,000 $12,922,314 $ (303,864) $ 17,252 $12,635,702
Comprehensive income:
Net Income 323,365 323,365
Unrealized loss on securities
available-for-sale, net (193,705) (193,705)
-----------
Total comprehensive income 129,660
--------- ----------- ---------- --------- -----------
BALANCE, JUNE 30, 2004 1,430,000 $12,922,314 $ 19,501 $(176,453) $12,765,362
========= =========== ========== ========= ===========
BALANCE AT JANUARY 1, 2005 1,430,000 $12,922,314 $ 499,783 $ (22,763) $13,399,334
Proceeds from the exercise of
stock options 2,800 28,684 28,684
Comprehensive income:
Net income 704,652 704,652
Unrealized loss on securities
available-for-sale, net (75,965) (75,965)
-----------
Total comprehensive income 628,687
--------- ----------- ---------- --------- ------------
BALANCE AT JUNE 30, 2005 1,432,800 $12,950,998 $1,204,435 $ (98,728) $14,056,705
========= =========== ========== ========= ============
See accompanying notes to consolidated financial statements.
-3-
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASHFLOW
(UNAUDITED)
Six Months Six Months
Ended Ended
June 30, 2005 June 30, 2004
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 704,652 $ 323,365
Adjustments to reconcile net income to net cash
from operating activities
Provision for loan losses 247,757 215,274
Depreciation and amortization 144,836 154,307
Net (accretion)/amortization of securities 16,175 60,370
Net realized gain on disposition of securities 0 6,600
Net realized gain on sale of loans (16,435) (14,588)
Loans originated for sale (2,261,150) (1,299,900)
Proceeds from loan sales 2,147,585 1,225,488
Net change in:
Accrued interest receivable and other assets 716 126,580
Accrued interest payable and other liabilities 65,466 (119,490)
------------ ------------
Net cash from operating activities 1,049,602 678,006
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in available-for-sale securities:
Sales 0 7,678,458
Maturities, prepayments and calls 1,126,981 6,626,198
Purchases 0 (6,511,638)
Activity in held-to-maturity securities
Maturities 105,000 28,571
Purchases (3,066,422) (244,625)
Loan originations and payments, net (15,407,946) (10,899,340)
Additions to premises and equipment (1,163,617) (78,685)
------------ ------------
Net cash used in investing activities (18,406,004) (3,401,061)
CASH FLOW FROM FINANCING ACTIVITIES
Net change in deposits 32,730,933 2,297,691
Net change in federal funds purchased and
repurchase agreements (4,205,647) (2,374,716)
Draws (paydown) on note payable 0 400,000
Net proceeds from the exercise of stock options 28,684 0
------------ ------------
Net cash from financing activities 28,553,970 322,975
------------ ------------
Net change in cash and cash equivalents 11,197,568 (2,400,080)
Beginning cash and cash equivalents 2,375,615 6,590,025
------------ ------------
ENDING CASH AND CASH EQUIVALENTS $ 13,573,183 $ 4,189,945
============ ============
Supplemental cash flow information:
Cash paid during the period for Interest $ 2,243,484 $ 1,906,823
Cash paid for federal income tax $ 380,000 $ 210,000
See accompanying notes to consolidated financial statements.
-4-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION:
The unaudited, consolidated financial statements as of and for the three
months and six months ended June 30, 2005 include the consolidated results
of operations of Community Shores Bank Corporation ("Company") and its
wholly-owned subsidiaries, Community Shores Bank ("Bank") and Community
Shores Financial Services, and a wholly-owned subsidiary of the Bank,
Community Shores Mortgage Company ("Mortgage Company"). These consolidated
financial statements have been prepared in accordance with the instructions
for Form 10-QSB and Item 310(b) of Regulation S-B and do not include all
disclosures required by generally accepted accounting principles for a
complete presentation of the Company's financial condition and results of
operations. In the opinion of management, the information reflects all
adjustments (consisting only of normal recurring adjustments) which are
necessary in order to make the financial statements not misleading and for
a fair representation of the results of operations for such periods. The
results for the period ended June 30, 2005 should not be considered as
indicative of results for a full year. For further information, refer to
the consolidated financial statements and footnotes included in the
Company's annual report on Form 10-KSB for the period ended December 31,
2004. Some items in the prior year financial statements were reclassified
to conform to the current presentation.
Earnings per share: Basic earnings per share is based on weighted average
common shares outstanding during the period. Diluted earnings per share
include the dilutive effect of additional potential common shares issuable
under stock options.
New Accounting Pronouncements: FAS 123, Revised, requires companies to
record compensation cost for stock options provided to employees in return
for employment service. The cost is measured at the fair value of the
options when granted, and this cost is expensed over the employment service
period, which is normally the vesting period of the options. This will
apply to awards granted or modified in fiscal years beginning after June
15, 2005. Compensation cost will also be recorded for prior option grants
that vest after the date of adoption. The effect on results of operations
will depend on the level of future option grants and the calculation of the
fair value of the options granted at such future date, as well as the
vesting period provided, and so cannot currently be predicted. There will
be no significant effect on financial position as total equity will not
change.
2. STOCK COMPENSATION
Employee compensation expense under stock options is reported using the
intrinsic value method. No stock-based compensation cost is reflected in
net income, as all options granted had an exercise price equal to or
greater than the market price of the underlying common stock at date of
grant. The following table illustrates what the effect on the net income
and the earnings per share would be if expense were measured using the fair
value recognition provisions of FASB Statement No. 123, Accounting for
Stock-Based Compensation.
-5-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2. STOCK COMPENSATION-continued
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2005 June 30, 2004 June 30, 2005 June 30, 2004
------------- ------------- ------------- -------------
Net income as reported $342,513 $154,316 $704,652 $323,365
Deduct: stock-based compensation expense
determined under fair value based method mmmemmethod 2,311 5,726 4,622 11,453
-------- -------- -------- --------
Pro forma net income 340,202 148,590 700,030 311,912
Basic earnings per share as reported $ .24 $ .11 $ .49 $ .23
Diluted earnings per share as reported $ .23 $ .11 $ .48 $ .22
Pro forma basic earnings per share $ .24 $ .10 $ .49 $ .22
Pro forma diluted earnings per share $ .23 $ .10 $ .48 $ .21
No options have been granted in 2005.
3. SECURITIES
The following tables represent the securities held in the Company's
portfolio at June 30, 2005 and at December 31, 2004:
Gross Gross
Amortized Unrealized Unrealized Fair
June 30, 2005 Cost Gains Losses Value %
- ----------------------------------- ---------- ---------- ---------- ----------- ----
Available for sale:
US Government and federal agency $ 0 $(139,639) $ 5,390,165 28.9
Municipal securities 12,488 (6,699) 715,732 3.9
Mortgage-backed securities 40,922 (56,660) 9,168,213 49.2
------- --------- ----------- ----
$53,410 $(202,998) $15,274,110 82.0
Held to maturity:
Municipal securities $3,359,398 $ 6,632 $ (11,658) $ 3,354,372 18.0
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2004 Cost Gains Losses Value %
- ----------------------------------- --------- ---------- ---------- ----------- ----
Available for sale:
US Government and federal agency $ 0 $(126,198) $ 5,406,061 31.9
Municipal securities 17,874 (3,626) 725,574 4.3
Mortgage-backed securities 95,801 (18,340) 10,399,183 61.4
-------- --------- ----------- ----
113,675 (148,164) 16,530,818 97.6
Held to maturity:
Municipal securities $399,523 9,588 (88) 409,023 2.4
-6-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3. SECURITIES-continued
Below is the schedule of maturities for investments held at June 30, 2005:
Held to Maturity
Available for Sale -----------------------
Fair Amortized Fair
Value Cost Value
------------------ ---------- ----------
Due in one year or less $ -- $ 235,732 $ 235,627
Due from one to five years 4,987,303 0 0
Due in more than five years 1,118,593 3,123,666 3,118,745
Mortgage-backed 9,168,214 0 0
----------- ---------- ----------
$15,274,110 $3,359,398 $3,354,372
=========== ========== ==========
4. LOANS
Loans increased $15,275,510 since December 31, 2004. The components of the
outstanding balances, their percentage of the total portfolio and the
percentage increase from the end of 2004 to June 30, 2005 were as follows:
June 30, 2005 December 31, 2004 Percent
-------------------- -------------------- Increase/
Balance % Balance % (Decrease)
------------ ----- ------------ ----- ----------
Commercial $ 88,085,672 47.2% $ 80,385,707 46.9% 9.6%
Real Estate:
Commercial 64,408,630 34.4 56,484,601 32.9 14.0
Residential 8,539,444 4.6 7,210,940 4.2 18.4
Construction 1,137,809 0.6 2,205,563 1.3 (48.4)
Consumer 24,555,157 13.2 25,164,391 14.7 (2.4)
------------ ----- ------------ -----
186,726,712 100.0 171,451,202 100.0
------------ ===== ------------ =====
Less: allowance for loan losses 2,154,519 2,039,198
------------ ------------
$184,572,193 $169,412,004
============ ============
-7-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. ALLOWANCE FOR LOAN LOSSES
The following is a summary of activity in the allowance for loan losses
account for the three and six month periods ended June 30, 2005 and 2004:
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
06/30/05 06/30/04 06/30/05 06/30/04
------------ ------------ ---------- ----------
Beginning Balance $2,098,165 $1,917,273 $2,039,198 $1,927,756
Charge-offs
Commercial (23,670) -- (63,550) --
Real estate-commercial -- -- -- (23,408)
Real estate-residential -- -- -- --
Real estate-construction -- -- -- --
Consumer (55,751) (12,745) (96,697) (75,229)
---------- ---------- ---------- ----------
Total Charge-offs (79,421) (12,745) (160,247) (98,637)
Recoveries
Commercial -- -- -- 2,167
Real estate-commercial -- 2,166 -- 2,166
Real estate-residential -- -- -- --
Real estate-construction -- -- -- --
Consumer 5,440 2,352 27,811 18,717
---------- ---------- ---------- ----------
Total Recoveries 5,440 4,518 27,811 23,050
Provision for loan losses 130,335 158,397 247,757 215,274
---------- ---------- ---------- ----------
Ending Balance $2,154,519 $2,067,443 $2,154,519 $2,067,443
========== ========== ========== ==========
6. PREMISES AND EQUIPMENT
Period end premises and equipment were as follows:
June 30, December 31,
2005 2004
---------- ------------
Land & land improvements $1,677,045 $ 714,450
Buildings & building improvements 1,689,663 1,689,075
Furniture, fixtures and equipment 2,134,835 2,107,237
Construction in Process 261,612 88,916
---------- ----------
5,763,155 4,599,678
Less: accumulated depreciation 2,201,377 2,056,681
---------- ----------
$3,561,778 $2,542,997
========== ==========
-8-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. DEPOSITS
Deposit balances increased $32,730,933 since December 31, 2004. The
components of the outstanding balances, their percentage of the total
portfolio and the percentage increase from the end of 2004 through June 30,
2005 were as follows:
June 30, 2005 December 31, 2004 Percent
-------------------- -------------------- Increase/
Balance % Balance % (Decrease)
------------ ----- ------------ ----- ----------
Non-interest bearing
Demand $ 18,062,244 9.4% $ 13,153,038 8.3% 37.3%
Interest bearing
Checking 25,022,939 13.1 22,195,301 14.0 12.7
Money Market 18,132,765 9.5 27,993,852 17.6 (35.2)
Savings 14,964,243 7.8 13,654,541 8.6 9.6
Time, under $100,000 24,393,148 12.7 22,148,114 13.9 10.1
Time, over $100,000 90,976,117 47.5 59,675,677 37.6 52.5
------------ ----- ------------ -----
Total Deposits $191,551,456 100.0% $158,820,523 100.0%
============ ===== ============ =====
8. SHORT-TERM BORROWINGS
At both June 30, 2005 and December 31, 2004, the Company's short-term
borrowings were made up of repurchase agreements only. Since year-end 2004,
repurchase agreements decreased $4,205,647. The June 30, 2005 and December
31, 2004 information was as follows:
Repurchase Federal Funds
Agreements Purchased
----------- -------------
Outstanding at June 30, 2005 $ 5,775,131 $ 0
Average interest rate at period end 1.80% 0.00%
Average balance during period 8,632,189 4,344,696
Average interest rate during period 1.46% 3.02%
Maximum month end balance during period 10,776,372 10,600,000
Outstanding at December 31, 2004 $ 9,980,778 $ 0
Average interest rate at year end 1.24% 0.00%
Average balance during year 9,314,156 2,271,721
Average interest rate during year 1.16% 1.86%
Maximum month end balance during year 11,480,726 5,550,000
-9-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
9. FEDERAL HOME LOAN BANK BORROWINGS
The Bank was approved in the first quarter of 1999 to be a member of the
Federal Home Loan Bank of Indianapolis. Based on its current Federal Home
Loan Bank Stock holdings, the Bank has the capacity to borrow $8,500,000.
Each borrowing requires a direct pledge of securities or loans. At June 30,
2005, the Bank had assets with a market value of $10,006,278 pledged to the
Federal Home Loan Bank to support current borrowings. Details of the Bank's
outstanding borrowings at both June 30, 2005 and December 31, 2004 are:
Current June 30, December 31,
Maturity Date Interest Rate 2005 2004
- ----------------- ------------- ---------- ------------
March 24, 2010 5.99 1,500,000 1,500,000
November 3, 2010 5.95 2,000,000 2,000,000
December 13, 2010 5.10 2,500,000 2,500,000
---------- ----------
$6,000,000 $6,000,000
10. SUBORDINATED DEBENTURES
The subordinated debentures stemmed from a trust preferred security
offering. Community Shores Capital Trust I ("the Trust"), a business trust
formed by the Company, sold 4,500 Cumulative Preferred Securities ("trust
preferred securities") at $1,000 per security in a December 2004 offering.
The proceeds from the sale of the trust preferred securities were used by
the Trust to purchase an equivalent amount of subordinated debentures from
the Company. The trust preferred securities carry a floating rate of 2.05%
over the 3-month LIBOR. This was initially set at 4.55125% and is 5.54% at
June 30, 2005. The stated maturity is December 30, 2034. The securities are
redeemable at par on any interest payment date on or after December 30,
2009 with regulatory approval, if then required, and are, in effect,
guaranteed by the Company. Distributions on the trust preferred securities
are payable quarterly on March 30th, June 30th, September 30th and December
30th.
The most recent distribution was paid on June 30th, 2005. Under certain
circumstances, distributions may be deferred up to 20 calendar quarters.
However, during any such deferrals, interest accrues on any unpaid
distributions at a floating rate of 2.05% over the 3-month LIBOR.
11. COMMITMENTS AND OFF-BALANCE SHEET RISK
Some financial instruments are used to meet financing needs and to reduce
exposure to interest rate changes. These financial instruments include
commitments to extend credit and standby letters of credit. These involve,
to varying degrees, credit and interest-rate risk in excess of the amount
reported in the financial statements. Commitments to extend credit are
agreements to lend to a customer as long as there is no violation of any
condition established in the commitment, and generally have fixed
-10-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
expiration dates. Standby letters of credit are conditional commitments to
guarantee a customer's performance to another party. Exposure to credit
loss if the customer does not perform is represented by the contractual
amount for commitments to extend credit and standby letters of credit.
Collateral or other security is normally obtained for these financial
instruments prior to their use, and many of the commitments are expected to
expire without being used.
A summary of the notional and contractual amounts of outstanding financing
instruments with off-balance-sheet risk as of June 30, 2005 and December
31, 2004 follows:
June 30, December 31,
2005 2004
----------- ------------
Unused lines of credit and letters of credit $37,094,269 $33,705,002
Commitments to make loans 645,511 106,322
Commitments to make loans generally terminate one year or less from the
date of commitment and may require a fee. Since many of the above
commitments on lines of credit and letters of credits expire without being
used, the above amounts related to those categories do not necessarily
represent future cash commitments.
12. REGULATORY MATTERS
The Company and Bank are subject to regulatory capital requirements
administered by the federal banking agencies. Capital adequacy guidelines
and prompt corrective action regulations involve quantitative measures of
assets, liabilities, and certain off-balance-sheet items calculated under
regulatory accounting practices. Capital amounts and classifications are
also subject to qualitative judgments by regulators about components, risk
weightings, and other factors, and the regulators can lower classifications
in certain cases. Failure to meet various capital requirements can initiate
regulatory action that could have a direct material effect on the financial
statements.
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although
these terms are not used to represent overall financial condition. If
adequately capitalized, regulator approval is required to accept brokered
deposits. If undercapitalized, capital distributions are limited, as is
asset growth and expansion, and plans for capital restoration are required.
Capital to risk weighted
assets
------------------------ Tier 1 Capital
Total Tier 1 to average assets
----- ------ -----------------
Well capitalized 10% 6% 5%
Adequately capitalized 8 4 4
Undercapitalized 6 3 3
-11-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
12. REGULATORY MATTERS-continued
Actual capital levels and minimum required levels at June 30, 2005 and
December 31, 2004 for the Company and Bank were:
Minimum Required to
Be Well Capitalized
Minimum Required Under Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
------------------- ------------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ----- ----------- ----- ----------- -----
June 30, 2005
Total Capital (Tier 1 and Tier
2) to risk weighted assets
Consolidated $20,809,952 10.52% $15,817,695 8.00% $19,772,119 10.00%
Bank 20,515,520 10.38 15,812,348 8.00 19,765,435 10.00
Tier 1 (Core) Capital to risk
weighted assets
Consolidated 18,655,433 9.44 7,908,848 4.00 11,863,271 6.00
Bank 18,361,002 9.29 7,906,174 4.00 11,859,261 6.00
Tier 1 (Core) Capital to
average assets
Consolidated 18,655,433 8.90 8,381,811 4.00 10,477,264 5.00
Bank 18,361,002 8.76 8,379,332 4.00 10,474,165 5.00
December 31, 2004
Total Capital (Tier 1 and Tier
2) to risk weighted assets
Consolidated $19,961,293 11.15% $14,318,832 8.00% $17,898,540 10.00%
Bank 18,924,066 10.57 14,317,523 8.00 17,896,903 10.00
Tier 1 (Core) Capital to risk
weighted assets
Consolidated 17,896,127 10.00 7,159,416 4.00 10,739,124 6.00
Bank 16,884,868 9.43 7,158,761 4.00 10,738,142 6.00
Tier 1 (Core) Capital to
Average assets
Consolidated 17,896,127 9.35 7,659,276 4.00 9,574,095 5.00
Bank 16,884,868 8.73 7,733,178 4.00 9,666,473 5.00
The Company and the Bank were in the well-capitalized category at both June
30, 2005 and December 31, 2004. The Company is closely monitoring the
Bank's growth and for the foreseeable future expects to infuse additional
capital as necessary to maintain at least a 10% (well capitalized) total
capital to risk weighted assets ratio. See further discussion in the
Financial Condition section of the Management Discussion and Analysis
concerning the Company's sources for future capital contributions to the
Bank.
-12-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
The discussion below details the financial results of the Company and its wholly
owned subsidiaries, the Bank and Community Shores Financial Services, and the
Bank's subsidiary, the Mortgage Company through June 30, 2005 and is separated
into two parts which are labeled, Financial Condition and Results of Operations.
The part labeled Financial Condition compares the financial condition at June
30, 2005 to that at December 31, 2004. The part labeled Results of Operations
discusses the three month and six month periods ended June 30, 2005 as compared
to the same periods of 2004. Both parts should be read in conjunction with the
interim consolidated financial statements and footnotes included in Item 1 of
this Form 10-QSB.
This discussion and analysis and other sections of this 10-QSB contains
forward-looking statements that are based on management's beliefs, assumptions,
current expectations, estimates and projections about the financial services
industry, the economy, and about the Company, the Bank, the Mortgage Company and
Community Shores Financial Services. Words such as "anticipates", "believes",
"estimates", "expects", "forecasts", "intends", "is likely", "plans",
"projects", variations of such words and similar expressions are intended to
identify such forward-looking statements. These forward-looking statements are
intended to be covered by the safe-harbor provisions of the Private Securities
Litigation Reform Act of 1995. These statements are not guarantees of future
performance and involve certain risks, uncertainties and assumptions ("Future
Factors") that are difficult to predict with regard to timing, extent,
likelihood and degree of occurrence. Therefore, actual results and outcomes may
materially differ from what may be expressed or forecasted in such
forward-looking statements. The Company undertakes no obligation to update,
amend, or clarify forward looking statements, whether as a result of new
information, future events (whether anticipated or unanticipated), or otherwise.
Future Factors include, among others, changes in interest rates and interest
rate relationships; demand for products and services; the degree of competition
by traditional and non-traditional competitors; changes in banking regulation;
changes in tax laws; changes in prices, levies, and assessments; the impact of
technological advances; governmental and regulatory policy changes; the outcomes
of contingencies; trends in customer behavior as well as their ability to repay
loans; changes in the national and local economy; and other factors, including
risk factors, referred to from time to time in filings made by the Company with
the Securities and Exchange Commission. These are representative of the Future
Factors that could cause a difference between an ultimate actual outcome and a
preceding forward-looking statement.
FINANCIAL CONDITION
Total assets increased by $29.2 million to $222.7 million at June 30, 2005 from
$193.5 million at December 31, 2004. This is a 15.1% increase in assets during
the first six months of 2005. Asset growth was funded by deposit growth and was
reflected by increases in balances held at other financial institutions, federal
funds sold, the security portfolio, the loan portfolio and premises and
equipment.
-13-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Cash and cash equivalents increased by $11.2 million to $13.6 million at June
30, 2005 from $2.4 million at December 31, 2004. This increase was reflective of
selling federal funds and differences in the size of the Bank's cash letter
deposit with its correspondent bank on June 30, 2005 and December 31, 2004.
These increases are related to fluctuations in the liquidity of the Bank and its
customers on those particular days.
The total security portfolio increased by a net amount of $1.7 million since
December 31, 2004. Securities held to maturity increased $3.0 million but was
offset by a reduction of $1.3 million in the available for sale portion of the
portfolio. Additions made to the held to maturity section of the portfolio
consisted entirely of municipal bonds. Municipal bond interest receives
favorable tax treatment thus such purchases are part of the overall tax planning
strategy of management. The reduction in the available for sale holdings is the
result of securities maturing, being called or receiving principal repayments.
Total loans climbed to $186.7 million at June 30, 2005 from $171.5 million at
December 31, 2004. The $15.2 million net increase includes $15.6 million growth
in the commercial and commercial real estate portfolios, $1.3 million growth in
the residential real estate portfolio and a decline of $1.7 million in the
construction and consumer loan portfolios. The "wholesale" (commercial and
commercial real estate) lending focus applied since opening in 1999 continued
during the first six months of 2005. Presently, the commercial and commercial
real estate categories of loans comprise 81% of the Bank's total loan portfolio.
There are eight experienced commercial lenders on staff devoted to pursuing and
originating these types of loans. The level of growth achieved during the first
half of 2005 is indicative of a strengthening in both the national and local
economies. As the marketplace recovers management remains optimistic about
future opportunities in the market.
The Company attempts to mitigate interest rate risk in its loan portfolio in
many ways. The main approach is to balance the rate sensitivity of the portfolio
and manage extension risk(1). The loan maturities and rate sensitivity of the
loan portfolio at June 30, 2005 are included below:
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
----------- ----------- ----------- ----------- ------------
Commercial, financial and other $24,893,426 $30,973,091 $30,441,723 $ 1,777,432 $ 88,085,672
Real estate:
Commercial 5,552,177 12,810,378 45,711,538 334,537 64,408,630
Residential 51,247 177,766 1,094,093 7,216,338 8,539,444
Construction 265,402 872,407 -- -- 1,137,809
Installment loans to individuals 1,375,838 2,945,914 17,927,668 2,305,737 24,555,157
----------- ----------- ----------- ----------- ------------
$32,138,090 $47,779,556 $95,175,022 $11,634,044 $186,726,712
=========== =========== =========== =========== ============
Loans at fixed rates $ 4,383,633 $ 5,180,004 $59,945,640 $ 5,906,582 $ 75,415,859
Loans at variable rates 27,754,457 42,599,552 35,229,382 5,727,462 111,310,853
----------- ----------- ----------- ----------- ------------
$32,138,090 $47,779,556 $95,175,022 $11,634,044 $186,726,712
=========== =========== =========== =========== ============
- ----------
(1) Extension risk, as related to loans, exists when booking fixed rate loans
with long final contractual maturities. When a customer is contractually
allowed longer to return their borrowed principal and rates rise, the Bank
is delayed from taking advantage of the opportunity to reinvest the
returning principal at the higher market rate.
-14-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
At June 30, 2005, 40% of the loan balances carried a fixed rate and 60% a
floating rate and only 6% of the entire portfolio had a contractual maturity
longer than five years.
The loan portfolio is reviewed and analyzed on a regular basis for the purpose
of estimating probable incurred credit losses. The allowance for loan losses is
adjusted accordingly to maintain an adequate level based on that analysis given
the risk characteristics of the loan portfolio. At June 30, 2005, the allowance
totaled $2.2 million or approximately 1.15% of gross loans outstanding.
Management has determined that this is an appropriate level based on its
detailed review of the loan portfolio using a consistent methodology involving
loan ratings, delinquency trends, historical loss experience as well as current
economic conditions.
June 30, 2005 December 31, 2004
-------------------------- --------------------------
Percent of Percent of
Allowance Allowance
Related to Related to
Amount Loan category Amount Loan category
---------- ------------- ---------- -------------
Balance at End of Period Applicable to:
Commercial $1,072,156 49.8% $1,062,232 52.1%
Real estate:
Commercial 746,649 34.7 632,459 31.0
Residential 43,347 2.0 36,055 1.8
Construction 13,085 0.6 25,364 1.2
Consumer 279,282 12.9 283,088 13.9
Unallocated 0 0.0 0 0.0
---------- ----- ---------- -----
Total $2,154,519 100.0% $2,039,198 100.0%
========== ===== ========== =====
The credit rating of a significant commercial loan customer was upgraded in the
first half of the year and the specific allocation related to the credit was
removed. Based on the methodology of the Bank's allowance for loan loss
calculation, a lower allocation was necessary as a result of this change. The
ratio of allowance for loan losses to total loans declined to 1.15% from a level
of 1.19% at December 31, 2004 in spite of the significant growth in the
commercial loan portfolio as a whole. Based on management's analysis, an
additional $248,000 was added to the allowance during for the first half of 2005
with $130,000 being added in the second quarter.
Another factor considered in the assessment of the adequacy of the allowance is
the quality of the loan portfolio from a past due standpoint. Below is a table,
which details the past due balances at June 30, 2005 compared to those at
year-end 2004 and the corresponding change, related to those two periods.
June 30, December 31, Increase
2005 2004 (Decrease)
---------- ------------ ---------
Loans Past Due:
30-59 days $1,026,000 $541,000 $ 485,000
60-89 days 362,000 306,000 56,000
90 days and greater 276,000 598,000 (322,000)
Non accrual notes 758,000 155,000 603,000
-15-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Since year-end 2004, overall past due and non-accrual loans have increased by
$822,000. A portion of the increase is related to a commercial lending
relationship comprised of three loans. The total of these loans is $258,000. At
June 30, 2005, two of the loans were past due 30-59 days and one was past due
over 90 days. None of the three loans were past due at year-end. The customer is
involved in the farming industry, which is highly seasonal and generally slow
during the winter months. At this time, there are no losses expected as a result
of this relationship and it is anticipated that the loans will be paid current
in the near future. Additionally, in the commercial 30-59 day past due category
there were two customers (notes totaling $159,000) that were in the process of
renewing their notes but unfortunately the paperwork was not completed before
June 30. As of July 31, the notes had been renewed.
Retail past due totals also increased since year-end. Borrowers with loans
totaling $130,000, considered past due (in the 30-59 day category) at quarter
end, made payments in July bringing their loans current. Three loans totaling
$171,000 have been put on non accrual since year-end and are in various stages
of foreclosure. The balances in non accrual are reflective of the anticipated
settlements. No further losses are anticipated.
Although the collection process is believed to be sound, there was still the
need to charge-off loans. There were net charge-offs of $132,000 recorded for
the first six months of 2005, which is higher than net charge-offs of $76,000
for the similar period in 2004. Additionally, there was a shift in the
proportion of commercial loan charge-offs between the two periods. One of the
commercial notes charged off was made to a nationally chartered non profit
entity that ceased operations. The loan had a specific allocation in the loan
loss allowance for the entire amount ($37,000). As the total size of the loan
portfolio increases it is anticipated that net charge-offs will increase.
Annualized, net charge-offs to average loans was 0.14% for the first half of
2005.
Premises and equipment increased by a net figure of $1.0 million. The majority
of the increase is related to property purchased on February 15, 2005. On that
date, the Bank paid $962,595 for a two acre parcel of vacant land at Harvey and
Mt. Garfield Road, in Norton Shores, for the establishment of the Bank's fourth
banking location. Construction will begin in late summer and the branch is
anticipated to be operational in the third quarter of 2006. In April, the Bank
also arranged to purchase a new check-processing machine. The cost is
approximately $385,000. The equipment was installed in May. It allows the Bank
to offer enhanced electronic banking to its account holders, which should help
to retain and attract customers. Management believes that this was a necessary
expenditure to allow the Bank to maintain its competitive position in the local
marketplace. Finally, the Bank has signed a purchase agreement on property in
North Muskegon and is in the concluding stages of performing environmental due
diligence. The agreed on purchase price is $855,000. If the property purchase is
completed the Bank intends on building a branch for its North Muskegon location.
The current North Muskegon banking location is leased.
Deposit balances were $191.6 million at June 30, 2005 up from $158.8 million at
December 31, 2004. Total deposit growth since year-end was $32.8 million or 21%.
Non-interest bearing and interest bearing checking accounts together with
savings accounts grew $9.0 million but was offset by declines totaling $9.9
million in money market accounts. One public fund customer reduced its balance
by $6.8 million, which accounted for 76% of the decline in
-16-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
money market accounts. It is typical for certain public fund customers to have
large balance fluctuations, particularly in the second quarter of the year.
Time deposit growth totaled over $33.5 million in the first six months of the
year. Time deposits over $100,000 reflected 96% of total deposit growth. $11.9
million of the growth in the time deposits over $100,000 is mainly due to
several of the Bank's large public fund customers increasing their holdings of
time deposits during the first half of the year. Many of these particular
customer certificates have short maturities. Based on their cash flow needs the
certificates were written to mature in the third quarter of 2005. At maturity,
the money is expected to be used to fund commitments outside of the Bank. The
additional growth in time deposits is the result of a newspaper advertising
campaign conducted locally beginning in March and the solicitation of brokered
deposits.
Brokered deposits are time deposits obtained from depositors located outside of
the Bank's market area and are placed with the Bank by a deposit broker. The net
increase in brokered deposits since year-end was $15.4 million. The
concentration of brokered deposits to total deposits was 35.3% at June 30, 2005
and 33.0% at December 31, 2004. When the loan portfolio grows more quickly than
local deposits it is helpful to use this means in order to maintain the Bank's
liquidity. In a rising rate environment, it is difficult to attract medium and
long term local deposits as most customers prefer short term maturities in order
to more quickly take advantage of higher rates. Using brokered deposits allows
the Bank to have more control over the timing of maturities thus matching them
more closely to the terms of the loans being booked.
Repurchase agreements and federal funds purchased decreased $4.2 million (42%)
from January 1, 2005 through June 30, 2005. No federal funds were purchased at
either period end. Half of the decline in repurchase agreements is the effect of
existing customers decreasing their invested balances from those held at
year-end 2004; the other half stems from customers being switched to the Bank's
Premium Sweep product (affecting overall growth in savings account balances).
The Bank had three Federal Home Loan Bank ("FHLB") putable advances outstanding,
totaling $6,000,000, at both June 30, 2005 and December 31, 2004. All three
putable advances are eligible to convert to a floating rate index at the option
of the FHLB (put option). The FHLB has not exercised its right to convert any of
these advances. The putable advances continue to accrue interest at rates of
5.10%, 5.95% and 5.99%. The FHLB has the right to exercise its put option every
ninety days. At this time, it is not anticipated that any of the advances will
convert to a floating rate in the short term, however as interest rates continue
to rise, the FHLB may be inclined to convert. In the event that any of the three
notes convert to a floating rate, management has the right to pay off the note
with no pre-payment fee. The scheduled maturities of the notes are all in 2010.
At June 30, 2005 and December 31, 2004, the Company had net subordinated
debentures of $4.5 million resulting from a pooled trust preferred offering on
December 17, 2004. From the date of the offering through the end of the second
quarter, $700,000 of the proceeds had been contributed as capital to the Bank to
maintain capital ratios at a designated level of well-capitalized.
-17-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
The shareholders' equity totaled $14.1 million and $13.4 million at June 30,
2005 and December 31, 2004 respectively. The earnings recorded in the first half
were offset by declines in accumulated other comprehensive income (security
market value adjustments). For the first six months and second quarter of 2005,
the annualized return on the Company's average total assets was 0.68% and 0.65%,
respectively, which compares favorably to 0.34% and 0.32% annualized return for
the same periods in 2005. The Company's annualized return on average equity was
10.29% and 9.88% for the first half and second quarter of 2005 and 5.01% and
4.76% for the first half and second quarter of 2004. The ratio of average equity
to average assets was 6.65% and 6.61% for the first half and second quarter of
2005 and 6.77% and 6.79% for the same periods in 2004.
RESULTS OF OPERATIONS
The net income for the first six months of 2005 was $705,000, which was 118%
more than the net income of $323,000 recorded in the first six months of 2004.
The corresponding weighted average earnings per share were $.49 for the first
six months of 2005 and $.23 for the similar period in 2004. A substantial factor
in the improvement in earnings of $381,000 between the first six months of 2005
and 2004 was an increase in net interest income.
Net income for the second quarter of 2005 was $343,000 while net income for the
same period in 2004 was $154,000. The Company's second quarter earnings improved
$189,000 or 123% from 2004 to 2005.
As mentioned above, the most important differences between the operating results
of the first half of 2004 and that of 2005 is the net interest income and the
net interest margin. The following table sets forth certain information relating
to the Company's consolidated average interest earning assets and interest
bearing liabilities and reflects the average yield on assets and average cost of
liabilities for the periods indicated. Such yields and costs are derived by
dividing annualized income or expenses by the average daily balance of assets or
liabilities, respectively, for the periods presented.
-18-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Six months ended June 30:
-------------------------------------------------------------------------------
2005 2004
-------------------------------------- --------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------------ ---------- ---------- ------------ ---------- ----------
Assets
Federal funds sold and interest-
bearing deposits with banks $ 1,351,215 $ 17,272 2.56% $ 5,463,511 $ 25,294 0.93%
Securities (including FHLB stock) 17,897,696 330,717 3.70 19,051,906 300,307 3.15
Loans (1) 179,761,511 5,921,243 6.59 157,513,492 4,601,650 5.84
------------ ---------- ------ ------------ ---------- ------
199,010,422 6,269,232 6.30 182,028,909 4,927,251 5.41
Other assets 6,852,547 8,659,643
------------ ------------
$205,862,969 $190,688,552
============ ============
Liabilities and Shareholders' Equity
Interest bearing deposits $152,795,808 $1,911,376 2.50 $145,622,218 $1,626,311 2.23
Federal funds purchased and
repurchase agreements 12,976,885 128,453 1.98 9,810,626 54,298 1.11
Note Payable and Federal Home
Loan Bank Advances 10,500,000 283,108 5.39 8,653,297 243,841 5.64
------------ ---------- ------ ------------ ---------- ------
176,272,693 2,322,937 2.64 164,086,141 1,924,450 2.35
---------- ----------
Non-interest bearing deposits 15,207,491 13,004,328
Other liabilities 691,667 687,078
Shareholders' Equity 13,691,118 12,911,005
------------ ------------
$205,862,969 $190,688,552
============ ============
Net interest income $3,946,295 $3,002,801
========== ==========
Net interest spread on earning assets 3.66% 3.07%
====== ======
Net interest margin on earning assets 3.97% 3.30%
====== ======
Average interest-earning assets to
Average interest-bearing liabilities 112.90% 110.93%
====== ======
The net interest spread on average earning assets increased 59 basis points to
3.66% since June 30, 2004 and the net interest margin for the same period
increased 67 basis points to 3.97%. Year to date net interest income was $3.9
million in 2005 compared to a figure of $3.0 million for the same six months in
2004, an increase of $900,000 or 30%. The additional net interest income was
representative of increases in the Bank's average internal prime lending rate,
the repricing lag on deposit rate increases as well as a more leveraged balance
sheet overall.
The average rate earned on interest earning assets was 6.30% for the six months
ended June 30, 2005 compared to 5.41% for the same period in 2004. The main
contributing factor was a 75 basis point increase in the yield on loans, the
Bank's largest earning asset category. A majority of the increase can be
attributed to differences in the Bank's internal prime rate. There was a 167
basis point difference in the internal prime rate between the two periods shown
above. Internal prime rate changes, no matter what direction, affect interest
earned on variable rate loans and new loan volume. At June 30, 2005, 60% of the
Bank's loan portfolio was
- ----------
(1) Includes loans held for sale and non-accrual loans.
-19-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
variable and $8.9 million (59%) of the loan volume experienced in the first half
of 2005 was booked into the variable portion of the loan portfolio.
Interest expense incurred on deposits, repurchase agreements, federal funds
purchased, Federal Home Loan Bank advances and Notes Payable rose 21% for the
first six months of 2005 compared to the first six months of 2004. Total
interest expense was $2.3 million for the six-month period ending June 30, 2005,
which was a $398,000 increase over the total recorded for the first six months
of 2004. The unfavorable change in the yield paid on interest bearing
liabilities and repurchase agreements was responsible for the higher cost of
funds. The average rate paid on interest-bearing products in the first half of
2005 was 29 basis points more than what was paid for the same period one year
earlier.
The significant lag between the timing of loan rate increases and increases in
the Bank's cost of funds is coming to an end. Local deposit rates have been
rising at a marked pace; often faster than increases in internal lending rates.
Local competitor's deposit rates are closely monitored and offering rates will
be adjusted as deemed appropriate. A second factor was the refinance of the
Company's debt. The subordinated debentures that were issued in December 2004
accrue interest at a lower rate than the notes payable that were in place in
June 2004. The average rate difference was 25 basis points between the two six
month periods. In addition to internal prime rate increases, both of the above
events have been instrumental in improving the Bank's net interest margin.
The quarter-to-quarter comparison of consolidated average interest earning
assets and interest bearing liabilities and average yield on assets and average
cost of liabilities for the second quarter ended June 30, 2005 and 2004 is in
the table below.
-20-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three months ended June 30:
-------------------------------------------------------------------------------
2005 2004
-------------------------------------- --------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------------ ---------- ---------- ------------ ---------- ----------
Assets
Federal funds sold and interest-
bearing deposits with banks $ 985,198 $ 2,243 0.91% $ 5,012,296 $ 11,507 0.92%
Securities (including FHLB stock) 18,290,812 172,933 3.78 17,492,525 126,590 2.89
Loans (1) 182,909,970 3,098,902 6.78 159,752,716 2,317,827 5.80
------------ ---------- ------ ------------ ---------- ------
202,185,980 3,274,078 6.48 182,257,537 2,455,924 5.39
Other assets 7,359,300 8,560,570
------------ ------------
$209,545,280 $190,818,107
============ ============
Liabilities and Shareholders' Equity
Interest bearing deposits $155,732,505 $1,055,047 2.71 $145,842,243 $ 809,318 2.22
Federal funds purchased and
repurchase agreements 12,739,289 71,904 2.26 9,452,417 26,128 1.11
Note Payable and Federal Home
Loan Bank Advances 10,500,000 145,357 5.54 8,752,198 123,306 5.64
------------ ---------- ------ ------------ ---------- ------
178,971,794 1,272,308 2.84 164,046,858 958,752 2.34
---------- ----------
Non-interest bearing deposits 15,853,004 13,149,018
Other liabilities 865,777 667,667
Shareholders' Equity 13,854,705 12,954,564
------------ ------------
$209,545,280 $190,818,107
============ ============
Net interest income $2,001,770 $1,497,172
========== ==========
Net interest spread on earning assets 3.63% 3.05%
====== ======
Net interest margin on earning assets 3.96% 3.29%
====== ======
Average interest-earning assets to
Average interest-bearing liabilities 112.97% 111.10%
====== ======
An analysis of the net interest income shows that the Bank was able to increase
its interest income by more than its increase in interest expense. Thus, net
interest income improved by $505,000. As a result of this positive outcome,
there was an improvement in the Bank's net interest margin of 67 basis points
between the second quarter of 2005 and the same period in 2004. There was a 191
basis point difference in the internal prime lending rate between the two
periods.Future increases to the internal prime lending rate are not likely to be
as beneficial given the speed at which the Bank's cost of funds is rising.
As increases in the internal prime rate and cost of funds continue being a
possibility, asset liability management is an important tool for assessing and
monitoring liquidity and interest rate sensitivity. Liquidity management
involves the ability to meet the cash flow requirements of the Company's
customers. These customers may be either borrowers with credit needs or
depositors wanting to withdraw funds. Management of interest rate sensitivity
attempts to avoid widely varying net interest margins and achieve consistent net
interest income through periods of changing interest rates. Asset liability
management assists the Company in achieving
- ----------
(1) Includes loans held for sale and non-accrual loans.
-21-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
reasonable and predictable earnings and liquidity by maintaining a balance
between interest-earning assets and interest-bearing liabilities.
The Company uses a sophisticated computer program to perform analysis of
interest rate risk, assist with asset liability management, and model and
measure interest rate sensitivity. Interest rate sensitivity varies with
different types of earning assets and interest-bearing liabilities. Overnight
investments, on which rates change daily, and loans tied to the prime rate,
differ considerably from long term investment securities and fixed rate loans.
Interest bearing checking and money market accounts are more interest sensitive
than long term time deposits and fixed rate FHLB advances. Comparison of the
repricing intervals of interest earning assets to interest bearing liabilities
is a measure of interest sensitivity gap. Balancing this gap is a continual
challenge in a changing rate environment. Details of the repricing gap at June
30, 2005 were:
Interest Rate Sensitivity Period
----------------------------------------------------------------------
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
------------ ------------ ----------- ----------- ------------
Earning assets
Interest-bearing deposits
In other financial institutions $ 278,224 $ 0 $ 0 $ 0 $ 278,224
Federal funds sold 6,650,000 0 0 0 6,650,000
Securities (including FHLB stock) 1,033,843 2,106,044 10,790,615 5,128,006 19,058,508
Loans (including held for sale) 109,473,814 11,209,455 61,560,249 4,613,194 186,856,712
------------ ------------ ----------- ----------- ------------
117,435,881 13,315,499 72,350,864 9,741,200 212,843,444
Interest-bearing liabilities
Savings and checking 58,119,947 0 0 0 58,119,947
Time deposits <$100,000 1,557,043 10,377,062 12,453,672 5,371 24,393,148
Time deposits >$100,000 26,117,006 25,591,887 39,267,224 0 90,976,117
Repurchase agreements and
Federal funds purchased 5,775,131 0 0 0 5,775,131
Notes payable and Federal Home
Loan bank advances 10,500,000 0 0 0 10,500,000
------------ ------------ ----------- ----------- ------------
102,069,127 35,968,949 51,720,896 5,371 189,764,343
Net asset (liability) repricing gap $ 15,366,754 $(22,653,450) $20,629,968 $ 9,735,829 $ 23,079,101
============ ============ =========== =========== ============
Cumulative net asset (liability)
Repricing gap $ 15,366,754 $ (7,286,696) $13,343,272 $23,079,101
============ ============ =========== ===========
Currently the Bank has a negative twelve month cumulative repricing gap which
indicates that the Bank is slightly liability sensitive. This position implies
that increases to the national federal funds rate would have more of an impact
on interest expense than on interest income if there were a parallel shift in
rates in the next twelve months. For instance if the Bank's internal prime rate
goes up by 25 basis points and interest earning assets and interest bearing
liabilities on the Bank's June 30, 2005 balance sheet (contractually able to
reprice in the next twelve months) adjusted simultaneously by the same 25 basis
points, more liabilities would be affected than assets. At this point in time it
would not be prudent to assume that deposit rates will only increase if the
national federal funds rate increases. The local marketplace has experienced
drastic increases in deposit rates as noted above. The interest rate sensitivity
table simply illustrates what the Company is contractually able to change in
certain timeframes.
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
The provision for loan losses for the second quarter and the first six months of
2005 were $130,000 and $248,000 compared to figures of $158,000 and $215,000 for
the same periods in 2004. Management believes that the allowance level is
adequate and justifiable based on the factors discussed earlier (see Financial
Condition). Management will continue to review the allowance with the intent of
maintaining it at an appropriate level. The provision may be increased or
decreased in the future as management continues to monitor the loan portfolio
and actual loan loss experience.
Non-interest income recorded in the first half of 2005 totaled $605,000 and
represented a 23% increase compared to last year's first half total, which was
$491,000. The main underlying factor was that service charge income was $106,000
higher in the first half of 2005 compared to the similar period in 2004.
Additional non-sufficient funds charges is the driving force behind the increase
in service charges. In December 2004, the Bank rolled out a new program called
Overdraft Privilege. The program allows customers to have an assigned overdraft
limit tied to their checking account within which presentments will be honored
and a service charge will be automatically assessed. The entire first half of
2005 was subject to this new program. The main risk with Overdraft Privilege is
that a customer will not bring their account back to a positive balance within a
short period of time causing the Bank to experience increased miscellaneous
losses. Management believes that there is adequate oversight of this program by
qualified Bank personnel and believes this should help to mitigate escalating
losses.
Mortgage loan referral fees and gains on loans sold recorded for the first six
months and the second quarter of 2005 were $19,000 and $3,000 respectively. For
the similar periods in 2004 the totals were $50,000 and $25,000. As the economy
improves mortgage rates have risen which makes refinancing an existing loan less
attractive to customers that have already taken advantage of the historically
low rates in the past two years. Management feels that the Bank is not overly
dependent on mortgage fees and that the level recognized in 2005's first quarter
is reasonable given the changes in the rate environment and the time of the
year. In spite of increased rates, there should continue to be a core amount of
business derived from new customers and new home purchases.
There were no security sales in the first half of 2005. During the first half of
2004, Management decided to liquidate four securities and use the proceeds to
fund loan growth. This transaction resulted in an $18,000 loss being recorded.
In the second quarter of 2004, Management approved an additional security
transaction, which resulted in a net gain of $11,000.
Other non interest income has improved $33,000 for the first six months of 2005
compared to the first two quarters of 2004. Other non interest income totaled
$153,000 through June 30, 2005. The improvement of 28% is mostly related to two
categories. Brokerage commissions increased $22,000 and debit card fees
increased $15,000. Both of these income streams are likely to increase along
with the size of the Bank's customer base.
Non-interest expenses for the first six months of 2005 were $3.2 million
compared to a total of $2.8 million for 2004, an increase of 14%. The second
quarter non-interest expense total was $1.7 million for 2005 and 1.4 million for
2004. The notable variances among the individual categories were in the areas of
salaries and benefits, advertising and professional services.
-23-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
On average there were an additional 6.5 full-time equivalent employees between
the same six month period in 2005 and that of 2004. These additions resulted in
an increase to salaries and benefits expense of 11%. Additions to staff are made
to support the growth of the Bank from both a sales and operational standpoint.
The $179,000 increase in salaries and benefits between the first half of 2005
and the similar period in 2004 accounts for 40% of the increase in total non
interest expenses.
Advertising expense was $86,000 in the first half of 2005, an increase of
$47,000 over advertising expense in the first half of 2004. The Bank initiated a
significant newspaper campaign throughout a large portion of the first six
months of the year in an attempt to attract local deposits to support
anticipated and experienced loan growth. Additionally the Bank instituted an
image campaign utilizing billboards throughout its marketplace. Management
expects to continue both programs throughout the remainder of the year.
Professional services expenses were $265,000 for the first half of 2005 compared
to $213,000 for the first six months of 2004, a 24% increase. Additional
accounting and legal fees associated with Sarbanes-Oxley Act compliance are
ongoing and expected. Additionally the Company has utilized a human
resource/benefits consultant to assist with the enhancement of several executive
level job descriptions and the development of an incentive plan that
incorporates more fully the long term strategic objectives of the organization.
The line item showing other non-interest expenses for the first six months of
2005 has increased $157,000 (33%) compared to the same period in 2004. The most
significant items supporting the increase were the rise in shareholder
relation's expenses, dues and subscriptions expenses, recruiting expenses and
loan collection expenses.
Management continues to enhance its shareholder relations program every year by
participating in banking conferences which highlight community bank stocks,
visiting various market makers in the investment community and improving its
distributed materials such as annual reports and quarterly brochures. These
costs increased $19,000 from the first six month period of 2005 compared to that
of 2004.
Dues and subscriptions increased $20,000 in the first half of 2005 compared to
the similar period in 2004. $17,000 of the total was fees associated with moving
to Nasdaq Small Cap Market in the first quarter of 2005. The Nasdaq Small Cap
Market fees will be ongoing.
Recruiting fees associated with recent staff additions together with added loan
collection expenses represent another $40,000 of the total increase in other non
interest expenses.
The $196,000 increase in federal tax expense is related to differences in
pre-tax income. The effective tax rate for both the first half of 2005 and 2004
was 34%.
ITEM 3. CONTROLS AND PROCEDURES
An evaluation was carried out under the supervision and with the participation
of the Company's management, including the Chief Executive Officer and Chief
Financial Officer, of the effectiveness of our disclosure controls and
procedures as of June 30, 2005. Based on the evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that the
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COMMUNITY SHORES BANK CORPORATION
Company's disclosure controls and procedures were, to the best of their
knowledge, effective as of June 30, 2005 with respect to information required to
be disclosed by the Company in reports that it files or submits under the
Exchange Act.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, the Company, the Bank, the Mortgage Company or Community
Shores Financial Services may be involved in various legal proceedings that are
incidental to their business. In the opinion of management, the Company, the
Bank, the Mortgage Company and Community Shores Financial Services are not a
party to any current legal proceedings that are material to their financial
condition, either individually or in the aggregate.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On February 18, 2005, the Company issued and sold 2,000 shares of its common
stock to a past director upon his exercise of a director stock option issued to
him under the Company's Director Stock Option Plan. The Company received an
exercise price of $10.23 per share, aggregating $20,460, for these shares. These
shares were sold in reliance on an exemption from registration under the
Securities Act of 1933, based on Section 4(2) of that Act, and Regulation D
issued under that Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At its annual meeting held on May 12, 2005, the Company's shareholders voted to
elect four Class I directors, Gary F. Bogner, Robert L. Chandonnet, Jose A.
Infante and Joy R. Nelson, each for a three year term expiring at the annual
meeting of the shareholders of the Company in 2008. The results of the election
were as follows:
Votes Votes Votes Broker Non-
Nominee For Withheld Abstained Votes
- ------- --------- -------- --------- -----------
Gary F. Bogner 1,281,098 35,250 0 0
Robert L. Chandonnet 1,308,503 7,845 0 0
Jose A. Infante 1,209,881 106,467 0 0
Joy R. Nelson 1,140,871 175,477 0 0
-25-
COMMUNITY SHORES BANK CORPORATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS-continued
The terms for the following directors (who were not up for election) continued
after the annual meeting: John C. Carlyle, Dennis L. Cherette, Bruce J. Essex,
Michael D. Gluhanich, John L. Hilt, Bruce C. Rice and Roger W. Spoelman.
Additionally, shareholders voted to approve the 2005 employee stock option plan.
The result of the vote was as follows:
Votes Votes Votes Broker Non-
For Against Abstained votes
- ------- ------- --------- -----------
748,922 101,530 4,750 0
Also, shareholders voted to approve the 2005 director stock option plan. The
result of the vote was as follows:
Votes Votes Votes Broker Non-
For Against Abstained votes
- ------- ------- --------- -----------
710,740 132,187 12,275 0
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- -------------------
3.1 Articles of Incorporation of the Company are incorporated by
reference to exhibit 3.1 of the Company's June 30, 2004 Form
10-QSB (SEC file number 333-63769).
3.2 Bylaws of the Company are incorporated by reference to exhibit 3.2
of the Company's December 31, 2003 Form 10-KSB (SEC file number
333-63769).
10.1 Purchase Agreement between Community Shores Bank and POT #103,
Inc. is incorporated by reference to exhibit 10.1 of the Company's
May 9, 2005 Form 8-K (SEC file number 000-51166).
10.2 Development Coordination Agreement with Investment Property
Associates, Inc. is incorporated by reference to exhibit 10.1 of
the Company's May 10, 2005 Form 8-K (SEC file number 000-51166).
-26-
COMMUNITY SHORES BANK CORPORATION
10.3 2005 Employee Stock Option Plan is incorporated by reference to
Appendix A of the Company's proxy statement for its May 12, 2005
annual meeting of shareholders that was filed with the Securities
and Exchange Commission (SEC file number 000-51166).
10.4 2005 Director Stock Option Plan is incorporated by reference to
Appendix B of the Company's proxy statement for its May 12, 2005
annual meeting of shareholders that was filed with the Securities
and Exchange Commission (SEC file number 000-51166).
10.5 Form of stock option agreement for options granted under the 2005
Employee Stock Option Plan is incorporated by reference to exhibit
10.3 of the Company's May 17, 2005 Form 8-K (SEC file number
000-51166).
31.1 Rule 13a-14(a) Certification of the principal executive officer.
31.2 Rule 13a-14(a) Certification of the principal financial officer.
32.1 Section 1350 Certification of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Section 1350 Certification of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
-27-
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, on August 15, 2005.
COMMUNITY SHORES BANK CORPORATION
By: /s/ Jose' A. Infante
------------------------------------
Jose' A. Infante
Chairman of the Board,
President and Chief
Executive Officer
(principal executive officer)
By: /s/ Tracey A. Welsh
------------------------------------
Tracey A. Welsh
Senior Vice President, Chief
Financial Officer and Treasurer
(principal financial and accounting
officer)
-28-
EXHIBIT INDEX
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- -------------------
3.1 Articles of Incorporation of the Company are incorporated by
reference to exhibit 3.1 of the Company's June 30, 2004 Form
10-QSB (SEC file number 333-63769).
3.2 Bylaws of the Company are incorporated by reference to exhibit 3.2
of the Company's December 31, 2003 Form 10-KSB (SEC file number
333-63769).
10.1 Purchase Agreement between Community Shores Bank and POT #103,
Inc. is incorporated by reference to exhibit 10.1 of the Company's
May 9, 2005 Form 8-K (SEC file number 000-51166).
10.2 Development Coordination Agreement with Investment Property
Associates, Inc. is incorporated by reference to exhibit 10.1 of
the Company's May 10, 2005 Form 8-K (SEC file number 000-51166).
10.3 2005 Employee Stock Option Plan is incorporated by reference to
Appendix A of the Company's proxy statement for its May 12, 2005
annual meeting of shareholders that was filed with the Securities
and Exchange Commission (SEC file number 000-51166).
10.4 2005 Director Stock Option Plan is incorporated by reference to
Appendix B of the Company's proxy statement for its May 12, 2005
annual meeting of shareholders that was filed with the Securities
and Exchange Commission (SEC file number 000-51166).
10.5 Form of stock option agreement for options granted under the 2005
Employee Stock Option Plan is incorporated by reference to exhibit
10.3 of the Company's May 17, 2005 Form 8-K (SEC file number
000-51166).
31.1 Rule 13a-14(a) Certification of the principal executive officer.
31.2 Rule 13a-14(a) Certification of the principal financial officer.
32.1 Section 1350 Certification of Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Section 1350 Certification of Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
-29-