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 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 No. 000-51166
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
incorporation or organization) Identification No.)
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
----- -----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act)
Yes No X
----- -----
At October 31, 2005, 1,436,800 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............................. 25
PART II. Other Information
Item 1. Legal Proceedings................................... 25
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds............................................ 26
Item 3. Defaults upon Senior Securities..................... 26
Item 4. Submission of Matters to a Vote of Security
Holders............................................. 26
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
September 30, December 31,
2005 2004
------------- ------------
(unaudited)
ASSETS
Cash and due from financial institutions $ 4,461,764 $ 2,214,088
Interest-bearing deposits in other financial institutions 54,718 161,527
Federal funds sold 3,150,000 0
------------ ------------
Cash and cash equivalents 7,666,482 2,375,615
Securities
Available for sale (at fair value) 14,564,811 16,530,818
Held to maturity (fair value of $4,411,725 at September 30, 2005 and
$409,023 at December 31, 2004) 4,445,253 399,523
------------ ------------
Total securities 19,010,064 16,930,341
Loans held for sale 0 0
Loans 187,262,814 171,451,202
Less: Allowance for loan losses 2,194,122 2,039,198
------------ ------------
Net loans 185,068,692 169,412,004
Federal Home Loan Bank stock 425,000 425,000
Premises and equipment, net 4,617,481 2,542,997
Accrued interest receivable 828,770 734,707
Other assets 1,247,843 1,081,944
------------ ------------
Total assets $218,864,332 $193,502,608
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Non-interest bearing $ 17,707,089 $ 13,153,038
Interest bearing 168,374,204 145,667,485
------------ ------------
Total deposits 186,081,293 158,820,523
Federal funds purchased and repurchase agreements 6,895,716 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 948,594 801,975
------------ ------------
Total liabilities 204,425,603 180,103,276
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;
1,436,800 & 1,430,000 issued at September 30, 2005
& December 31, 2004 12,991,918 12,922,314
Retained earnings 1,593,751 499,781
Accumulated other comprehensive loss (146,940) (22,763)
------------ ------------
Total shareholders' equity 14,438,729 13,399,332
------------ ------------
Total liabilities and shareholders' equity $218,864,332 $193,502,608
============ ============
See accompanying notes to consolidated financial statements.
-1-
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three Three Nine Nine
Months Ended Months Ended Months Ended Months Ended
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
------------- ------------- ------------- -------------
Interest and dividend income
Loans, including fees $3,334,559 $2,451,752 $9,255,802 $7,053,402
Securities and FHLB dividends 181,576 153,639 512,293 453,946
Federal funds sold and other income 39,953 626 57,225 25,920
---------- ---------- ---------- ----------
Total interest income 3,556,088 2,606,017 9,825,320 7,533,268
Interest expense
Deposits 1,260,477 784,030 3,171,853 2,410,341
Repurchase agreements, federal funds purchased,
and other debt 43,535 48,617 171,988 102,915
Federal Home Loan Bank advances and notes payable 151,781 127,327 434,889 371,168
---------- ---------- ---------- ----------
Total interest expense 1,455,793 959,974 3,778,730 2,884,424
---------- ---------- ---------- ----------
NET INTEREST INCOME 2,100,295 1,646,043 6,046,590 4,648,844
Provision for loan losses 98,300 182,374 346,057 397,648
---------- ---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 2,001,995 1,463,669 5,700,533 4,251,196
Noninterest income
Service charges on deposit accounts 236,699 160,392 670,202 487,611
Mortgage loan referral fees 5,752 10,977 7,872 46,556
Gain on sale of loans 3,717 7,141 20,152 21,729
Gain (loss) on disposition of securities 0 0 0 (6,600)
Other 72,336 56,883 225,552 176,871
---------- ---------- ---------- ----------
Total noninterest income 318,504 235,393 923,778 726,167
Noninterest expense
Salaries and employee benefits 991,226 801,130 2,740,725 2,372,080
Occupancy 83,086 74,931 231,484 229,581
Furniture and equipment 93,923 91,039 273,470 273,489
Advertising 32,058 5,622 118,485 44,803
Data processing 86,884 75,622 265,622 231,770
Professional services 131,219 124,049 396,528 337,179
Other 336,927 267,496 965,572 739,121
---------- ---------- ---------- ----------
Total noninterest expense 1,755,323 1,439,889 4,991,886 4,228,023
---------- ---------- ---------- ----------
INCOME BEFORE FEDERAL INCOME TAXES 565,176 259,173 1,632,425 749,340
Federal income tax expense 175,860 89,127 538,457 255,929
---------- ---------- ---------- ----------
NET INCOME $ 389,316 $ 170,046 $1,093,968 $ 493,411
========== ========== ========== ==========
Comprehensive income $ 341,104 $ 362,211 $ 969,791 $ 491,871
========== ========== ========== ==========
Weighted average shares outstanding 1,435,757 1,430,000 1,433,304 1,430,000
========== ========== ========== ==========
Diluted average shares outstanding 1,480,317 1,465,139 1,468,214 1,465,171
========== ========== ========== ==========
Basic earnings per share $ 0.27 $ 0.12 $ 0.76 $ 0.35
========== ========== ========== ==========
Diluted earnings per share $ 0.26 $ 0.12 $ 0.75 $ 0.34
========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
-2-
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED STATEMENT OF
CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
Accumulated
Accumulated Other Total
Common Earnings Comprehensive Shareholders'
Shares Stock (Deficit) 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 493,411 493,411
Unrealized loss on securities
available-for-sale, net (1,540) (1,540)
-----------
Total comprehensive income 491,871
--------- ----------- ---------- --------- -----------
BALANCE, SEPTEMBER 30, 2004 1,430,000 $12,922,314 $ 189,547 $ 15,712 $13,127,573
========= =========== ========== ========= ===========
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 6,800 69,604 69,604
Comprehensive income:
Net income 1,093,968 1,093,968
Unrealized loss on securities
available-for-sale, net (124,177) (124,177)
-----------
Total comprehensive income 969,791
--------- ----------- ---------- --------- -----------
BALANCE AT SEPTEMBER 30, 2005 1,436,800 $12,991,918 $1,593,751 $(146,940) $14,438,729
========= =========== ========== ========= ===========
See accompanying notes to consolidated financial statements.
-3-
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended Nine Months Ended
September 30, 2005 September 30, 2004
------------------ ------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 1,093,968 $ 493,411
Adjustments to reconcile net income to net cash
from operating activities
Provision for loan losses 346,057 397,648
Depreciation and amortization 221,589 348,620
Net (accretion)/amortization of securities 24,604 67,339
Net realized gain on disposition of securities 0 6,600
Net realized gain on sale of loans (20,152) (21,729)
Net realized gain on disposal of equipment (11,925) 0
Loan originations (2,569,050) (2,112,200)
Proceeds from loan sales 2,589,202 2,077,129
Net change in:
Accrued interest receivable and other assets (195,991) (7,577)
Accrued interest payable and other liabilities 146,619 (178,226)
------------ ------------
Net cash from operating activities 1,624,921 1,071,015
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in available-for-sale securities:
Sales 0 7,678,458
Maturities, prepayments and calls 1,756,322 7,212,490
Purchases 0 (6,631,632)
Activity in held-to-maturity securities
Maturities 105,000 28,571
Purchases (4,153,795) (244,625)
Loan originations and payments, net (16,002,745) (15,224,278)
Additions to premises and equipment (2,284,148) (235,600)
------------ ------------
Net cash used in investing activities (20,579,366) (7,416,616)
CASH FLOW FROM FINANCING ACTIVITIES
Net change in deposits 27,260,770 18,739,542
Net change in federal funds purchased and
repurchase agreements (3,085,062) (434,556)
Note payable activity:
New advances on LaSalle line of credit 0 3,200,000
New subordinated note 0 400,000
Repayment of subordinated debt 0 (2,950,000)
Proceeds from exercises of stock options 69,604 0
------------ ------------
Net cash from financing activities 24,245,312 18,954,986
------------ ------------
Net change in cash and cash equivalents 5,290,867 12,609,385
Beginning cash and cash equivalents 2,375,615 6,590,025
------------ ------------
ENDING CASH AND CASH EQUIVALENTS $ 7,666,482 $ 19,199,410
============ ============
Supplemental cash flow information:
Cash paid during the period for Interest $ 3,740,107 $ 2,848,947
Cash paid for federal income tax 735,000 305,000
-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 nine months ended September 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 September 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 Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
------------- ------------- ------------- -------------
Net income as reported $389,316 $170,046 $1,093,968 $493,411
Deduct: stock-based compensation expense
determined under fair value based method 2,311 5,726 6,933 17,180
-------- -------- ---------- --------
Pro forma net income 387,005 164,320 1,087,035 476,231
Basic earnings per share as reported $ .27 $ .12 $ .76 $ .35
Diluted earnings per share as reported $ .26 $ .12 $ .75 $ .34
Pro forma basic earnings per share $ .27 $ .11 $ .76 $ .33
Pro forma diluted earnings per share $ .26 $ .11 $ .74 $ .33
No options have been granted in 2005.
3. SECURITIES
The following tables represent the securities held in the Company's
portfolio at September 30, 2005 and at December 31, 2004:
Gross Gross
Amortized Unrealized Unrealized Fair
September 30, 2005 Cost Gains Losses Value %
- ------------------ ---------- ---------- ---------- ----------- ----
Available for sale:
US Government and federal agency $ 0 $(148,896) $ 5,379,590 28.3
Municipal securities 10,258 (6,500) 713,009 3.7
Mortgage-backed securities 13,460 (90,868) 8,472,212 44.6
------- --------- ----------- ----
$23,718 $(246,264) $14,564,811 76.6
Held to maturity:
Municipal securities $4,445,253 $ 6,642 $ (40,170) $ 4,411,725 23.4
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 September 30,
2005:
Held to Maturity
Available for Sale -----------------------
Fair Amortized Fair
Value Cost Value
------------------ ---------- ----------
Due in one year or less $ 984,442 $ 235,506 $ 235,289
Due from one to five years 4,986,735 0 0
Due in more than five years 121,422 4,209,747 4,176,436
Mortgage-backed 8,472,212 0 0
----------- ---------- ----------
$14,564,811 $4,445,253 $4,411,725
=========== ========== ==========
Since December 31, 2004, there has been a market value decline of $124,000
due to market conditions. As management has the ability to hold these debt
securities until maturity, or for the foreseeable future if classified as
available for sale, no declines are deemed to be other than temporary.
4. LOANS
Loans increased $15,811,612 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 September 30, 2005 were as
follows:
September 30, 2005 December 31, 2004 Percent
-------------------- -------------------- Increase/
Balance % Balance % (Decrease)
------------ ----- ------------ ----- ----------
Commercial $ 85,085,170 45.44% $ 80,385,707 46.9% 5.85%
Real Estate:
Commercial 63,972,631 34.16 56,484,601 32.9 13.26
Residential 9,002,088 4.81 7,210,940 4.2 24.84
Construction 1,652,680 0.88 2,205,563 1.3 (25.07)
Consumer 27,550,245 14.71 25,164,391 14.7 9.48
------------ ----- ------------ -----
187,262,814 100.0% 171,451,202 100.0 9.22
------------ ===== ------------ =====
Less: allowance for loan losses 2,194,122 2,039,198
------------ ------------
$185,068,692 $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 nine-month periods ended September 30, 2005 and
2004:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
09/30/05 09/30/04 09/30/05 09/30/04
------------ ------------ ----------- -----------
Beginning Balance $2,154,519 $2,067,443 $2,039,198 $1,927,756
Charge-offs
Commercial (21,616) (123,969) (85,166) (123,969)
Real estate-commercial -- -- -- (23,408)
Real estate-residential -- -- -- --
Real estate-construction -- -- -- --
Consumer (40,704) (85,928) (137,401) (161,157)
---------- ---------- ---------- ----------
Total Charge-offs (62,320) (209,897) (222,567) (308,534)
Recoveries
Commercial -- 757 -- 2,924
Real estate-commercial -- -- -- 2,166
Real estate-residential -- -- -- --
Real estate-construction -- -- -- --
Consumer 3,623 4,862 31,434 23,579
---------- ---------- ---------- ----------
Total Recoveries 3,623 5,619 31,434 28,669
Provision for loan losses 98,300 182,374 346,057 397,648
---------- ---------- ---------- ----------
Ending Balance $2,194,122 $2,045,539 $2,194,122 $2,045,539
========== ========== ========== ==========
6. PREMISES AND EQUIPMENT
Period end premises and equipment were as follows:
September 30, December 31,
2005 2004
------------- ------------
Land & land improvements $2,604,032 $ 714,450
Buildings & building improvements 1,689,663 1,689,075
Furniture, fixtures and equipment 2,192,662 2,107,237
Construction in Process 81,879 88,916
---------- ----------
6,568,237 4,599,678
Less: accumulated depreciation 1,950,756 2,056,681
---------- ----------
$4,617,481 $2,542,997
========== ==========
-8-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. DEPOSITS
Deposit balances increased $27,260,770 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
September 30, 2005 were as follows:
September 30, 2005 December 31, 2004
-------------------- -------------------- Increase/
Balance % Balance % (Decrease)
------------ ----- ------------ ----- ----------
Non-interest bearing
Demand $ 17,707,089 9.5% $ 13,153,038 8.3% 34.6%
Interest bearing
Checking 25,747,175 13.8 22,195,301 14.0 16.0
Money Market 18,006,881 9.7 27,993,852 17.6 (35.7)
Savings 14,329,744 7.7 13,654,541 8.6 4.9
Time, under $100,000 26,578,658 14.3 22,148,114 13.9 20.0
Time, over $100,000 83,711,746 45.0 59,675,677 37.6 40.3
------------ ----- ------------ -----
Total Deposits $186,081,293 100.0% $158,820,523 100.0%
============ ===== ============ =====
8. SHORT-TERM BORROWINGS
Repurchase agreements were outstanding at both September 30, 2005 and
December 31, 2004. No federal funds were outstanding on those dates. Since
year-end 2004, repurchase agreements decreased $3,085,062. The September
30, 2005 and December 31, 2004 information was as follows:
Repurchase Federal Funds
Agreements Purchased
----------- -------------
Outstanding at September 30, 2005 $ 6,895,716 $ 0
Average interest rate at period end 2.71% 0.00%
Average balance during period 8,042,693 3,152,161
Average interest rate during period 1.63% 3.12%
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
September 30, 2005, the Bank had assets with a market value of $11,719,968
pledged to the Federal Home Loan Bank to support current borrowings.
Details of the Bank's outstanding borrowings at both September 30, 2005 and
December 31, 2004 are:
Current September 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 6.07038%
at September 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 September 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)
11. COMMITMENTS AND OFF-BALANCE SHEET RISK-continued
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 September 30, 2005 and
December 31, 2004 follows:
September 30, December 31,
2005 2004
------------- ------------
Unused lines of credit and letters of credit $33,504,589 $33,705,002
Commitments to make loans 440,881 106,322
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 September 30, 2005 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
----------- ----- ----------- ----- ----------- -----
September 30, 2005
Total Capital (Tier 1 and Tier 2)
to risk weighted assets
Consolidated $21,279,791 10.88% $15,645,975 8.00% $19,557,469 10.00%
Bank 21,090,546 10.79 15,641,783 8.00 19,552,229 10.00
Tier 1 (Core) Capital to
risk weighted assets
Consolidated 19,085,669 9.76 7,822,987 4.00 11,734,481 6.00
Bank 18,896,424 9.66 7,820,892 4.00 11,731,338 6.00
Tier 1 (Core) Capital to
average assets
Consolidated 19,085,669 8.67 8,804,024 4.00 11,005,030 5.00
Bank 18,896,424 8.59 8,801,790 4.00 11,002,237 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
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
September 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 for the Bank. 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 September 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 September 30, 2005 to that at December 31, 2004. The part labeled
Results of Operations discusses the three month and nine month periods ended
September 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 grew 13.1% since December 31, 2004 increasing $25.4 million to
$218.9 million in the first nine months of 2005. Asset growth was funded by
deposit growth and was reflected by increases in federal funds sold, securities
and loans as well as increases in premises and equipment.
Cash and cash equivalents increased by $5.3 million to $7.7 million at September
30, 2005 from $2.4 million at December 31, 2004. This increase was reflective of
selling federal funds
-13-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
and differences in the size of the Bank's cash letter deposit with its
correspondent bank on September 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 $2.1 million since
December 31, 2004. Securities held to maturity increased $4.1 million but was
offset by a reduction of $2.0 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 $187.3 million at September 30, 2005 from $171.5 million
at December 31, 2004. The rate of loan growth was 9% for the first nine months
of the year. The $15.8 million net increase includes $12.2 million growth in the
commercial and commercial real estate portfolios, $1.8 million growth in the
residential real estate portfolio and increases of $1.8 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 nine months of 2005. Presently, the commercial and commercial
real estate categories of loans comprise 80% of the Bank's total loan portfolio.
There are nine experienced commercial lenders on staff devoted to pursuing and
originating these types of loans. The level of growth achieved during the first
nine months 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 September 30, 2005 are included below:
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
----------- ----------- ----------- ----------- ------------
Commercial, financial and other $15,253,072 $37,005,494 $30,981,317 $ 1,845,287 $ 85,085,170
Real estate:
Commercial 6,082,905 10,684,841 47,047,934 156,951 63,972,631
Residential 55,263 187,893 1,157,143 7,601,789 9,002,088
Construction 186,000 1,466,680 -- -- 1,652,680
Installment loans to individuals 1,313,626 3,613,655 19,945,616 2,677,348 27,550,245
----------- ----------- ----------- ----------- ------------
$22,890,866 $52,958,563 $99,132,010 $12,281,375 $187,262,814
=========== =========== =========== =========== ============
Loans at fixed rates $ 2,402,629 $ 5,826,908 $61,890,811 $ 5,710,743 $ 75,831,091
Loans at variable rates 20,488,237 47,131,655 37,241,199 6,570,632 111,431,723
----------- ----------- ----------- ----------- ------------
$22,890,866 $52,958,563 $99,132,010 $12,281,375 $187,262,814
----------- ----------- ----------- ----------- ------------
- ----------
(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 September 30, 2005, 40% of the loan balances carried a fixed rate and 60% a
floating rate and only 7% 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 September 30, 2005, the
allowance totaled $2.2 million or approximately 1.17% 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.
The allocation of the allowance at September 30, 2005 and December 31, 2004 were
as follows:
September 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 $1,120,203 51.1% $1,062,232 52.1%
Real estate:
Commercial 704,518 32.1 632,459 31.0
Residential 45,010 2.0 36,055 1.8
Construction 19,006 0.9 25,364 1.2
Consumer 305,385 13.9 283,088 13.9
Unallocated 0 0.0 0 0.0
---------- ----- ---------- -----
Total $2,194,122 100.0% $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 the allowance for loan losses to total loans declined to 1.17% 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 $346,000 was added to the allowance for the first three quarters of
2005 with $98,000 being added in the third 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. A portion of the
adequacy of the allowance takes into consideration the past due loans in the
portfolio. Below is a table, which details the past due balances at September
30, 2005 compared to those at year-end 2004 and the corresponding change,
related to those two periods.
-15-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Loans Past due: September 30, 2005 December 31, 2004 Increase (Decrease)
- --------------- ------------------ ----------------- -------------------
30-59 days $519,000 $541,000 ($22,000)
60-89 days $369,000 306,000 $ 63,000
90 days and greater $296,000 598,000 ($302,000)
Non accrual notes $539,000 155,000 $ 384,000
The past due and non accrual notes total $1.7 million at September 30, 2005, an
increase of $123,000 since year-end 2004. Although the total has increased, the
ratio of past dues and non accrual loans to total loans outstanding has
decreased. At the end of 2005's third quarter the ratio was 0.92% compared 0.93%
at December 31, 2004.
The Bank's collection process is believed to be sound, however there was still
the need to charge-off loans. There were net charge-offs of $191,000 recorded
for the first nine months of 2005, which is lower than net charge-offs of
$280,000 for the similar period in 2004. Annualized, net charge-offs to average
loans was 0.14% for the first three quarters of 2005 and 0.23% for the first
nine months of 2004. It is assumed that the improvement in the net charge-off
ratio is indicative of a strengthening economic environment.
Premises and equipment increased by a net figure of $2.1 million. The majority
of the increase is related to two property purchases. The first occurred on
February 15, 2005. On that date, the Bank paid $963,820 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 is scheduled
to begin in late fall. The second property purchase occurred on September 1,
2005. The property in North Muskegon is located at the corner of Ruddiman and
the Causeway. The purchase price was $925,762. The Bank intends to build on a
branch on this property for its North Muskegon location. The current North
Muskegon banking location is leased. Both branches are anticipated to be
operational in the fourth quarter of 2006.
Deposit balances were $186.1 million at September 30, 2005 up from $158.8
million at December 31, 2004. Total deposit growth since year-end was $27.3
million or 17%. Non-interest bearing and interest bearing checking accounts
together with savings accounts grew $8.8 million but was offset by declines
totaling $10.0 million in money market accounts. One public fund customer
reduced its balance by $7.6 million, which accounted for 76% of the decline in
money market accounts. It is typical for certain public fund customers to have
large balance fluctuations in the third quarter of the year as school is
resuming session.
Time deposit growth totaled over $28.5 million in the first nine months of the
year. Time deposits over $100,000, which grew $24.0 million, reflected 84% of
total deposit growth. Expansion in the time deposits over $100,000 is due in
part to two of the Bank's large public fund customers increasing their holdings
of time deposits during the first nine months of the year. The $6.0 million
increase in their holdings accounted for 22% of the total increase since
year-end 2004. 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
-16-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
deposits since year-end was $12.9 million and is responsible for 45% of the
increase in time deposits since December 31, 2004. The concentration of brokered
deposits to total deposits was 35.1% at September 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 30.9%, or $3.1
million since December 31, 2004. Since there were no Federal funds purchased on
either September 30, 2005 or on December 31, 2004, the entire decline is in the
repurchase balances. 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 eight 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 September 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 September 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 third
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.
The shareholders' equity totaled $14.4 million and $13.4 million at September
30, 2005 and December 31, 2004 respectively. The earnings recorded in the first
three quarters were offset by increases in accumulated other comprehensive loss
(security market value adjustments). For the first nine months and third quarter
of 2005, the annualized return on the Company's average total assets was 0.69%
and 0.71%, respectively, which compares favorably to 0.34% and 0.36% annualized
return for the same periods in 2004. The Company's annualized return on average
equity was 10.50% and 10.90% for the first nine months and third quarter of 2005
and 5.11% and 5.25% for the first nine months and third quarter of 2004. The
ratio of average equity to average assets was 6.59% and 6.49% for the first nine
months and third quarter of 2005 and 6.74% and 6.91% for the same periods in
2004.
-17-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
The net income for the first nine months of 2005 was $1.1 million, which was
123% more than the net income of $493,000 recorded in the first nine months of
2004. The corresponding weighted average diluted earnings per share were $.75
for the first three quarters of 2005 and $.34 for the similar period in 2004. A
substantial factor in the improvement in earnings of $601,000 for the first nine
months of 2005 was an increase in net interest income.
Net income for the third quarter of 2005 was $389,000 while net income for the
same period in 2004 was $170,000. The Company's third quarter earnings improved
$219,000 or 129% from 2004 to 2005.
As mentioned above, the most important differences between the operating results
of the first three quarters of 2004 and that of 2005 are 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
Nine months ended September 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 $ 2,509,265 $ 57,225 3.04% $ 3,703,736 $ 25,920 0.93%
Securities (including FHLB stock)(1) 18,522,144 555,022 4.00 18,307,571 465,596 3.39
Loans(2) 182,507,263 9,255,802 6.76 160,884,128 7,053,402 5.85
------------ ---------- ------ ------------ ---------- ------
203,538,672 9,868,049 6.46 182,895,435 7,544,918 5.50
Other assets 7,122,464 7,951,420
------------ ------------
$210,661,136 $190,846,855
============ ============
Liabilities and Shareholders' Equity
Interest bearing deposits $158,217,454 $3,171,853 2.67 $142,736,414 $2,410,341 2.25
Federal funds purchased and
repurchase agreements 11,194,854 171,988 2.05 11,078,531 102,915 1.24
Note Payable and Federal Home
Loan Bank Advances 10,500,000 434,889 5.52 8,819,526 371,168 5.61
------------ ---------- ------ ------------ ---------- ------
179,912,308 3,778,730 2.80 162,634,471 2,884,424 2.36
---------- ----------
Non-interest bearing deposits 16,074,574 14,678,954
Other liabilities 781,330 670,820
Shareholders' Equity 13,892,924 12,862,610
------------ ------------
$210,661,136 $190,846,855
============ ============
Net interest income (tax equivalent basis) 6,089,319 4,660,494
Net interest spread on earning assets (tax
equivalent basis) 3.66% 3.14%
====== ======
Net interest margin on earning assets (tax
equivalent basis) 3.99% 3.40%
====== ======
Average interest-earning assets to Average
interest-bearing liabilities 113.13% 112.46%
====== ======
Tax equivalent adjustment 42,729 11,650
---------- ----------
Net interest income $6,046,590 $4,648,844
========== ==========
The net interest spread on average earning assets increased 52 basis points to
3.64% since September 30, 2004. The net interest margin was 3.99% for the first
nine months of 2005 improving 59 basis points compared to the net interest
margin for the same period in 2004. Year to date net interest income was $6.0
million in 2005 compared to a figure of $4.6 million for the same nine months in
2004, an increase of $1.4 million or 30%. The additional net interest income was
representative of increases in the Bank's average earning assets, and 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 6.46% for the nine months
ended September 30, 2005 compared to 5.50% for the same period in 2004. The main
contributing factor was a 91 basis point increase in the yield on loans, the
Bank's largest earning asset category. The average internal prime rate increased
179 basis points between the first nine months of 2004 and that of 2005.
Internal prime rate changes, no matter what direction, affect
- ----------
(1) Adjusted to fully tax equivalent basis.
(2) Includes loans held for sale and non-accrual loans.
-19-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
interest earned on variable rate loans and new loan volume. Variable rate loans
made up 56% of the total loan portfolio at September 30, 2004. At September 30,
2005 variable rate loans comprised 60% of the total loan portfolio. At June 30,
2005, 60% of the Bank's loan portfolio was variable and $9.1 million (57%) of
the loan volume experienced in the first three quarters of 2005 was booked into
the variable portion of the loan portfolio. In a rising rate environment, it is
advantageous to have loans that are able to reprice with the market rates.
Interest expense incurred on deposits, repurchase agreements, federal funds
purchased, Federal Home Loan Bank advances, notes payable and subordinated
debentures increased 31% for the first nine months of 2005 compared to the first
nine months of 2004. Total interest expense was $3.8 million for the nine-month
period ending September 30, 2005, which was a $894,000 increase over the total
recorded for the first nine 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 deposit
products in the first nine months of 2005 was 42 basis points more than what was
paid for the same period one year earlier. The rate paid to repurchase agreement
customers increased 81 basis points between the similar periods. The rate paid
on debt actually decreased by 9 basis points as a result of the Company
refinancing its borrowings. The subordinated debentures that were issued in
December 2004 accrue interest at a lower rate than the notes payable that were
in place in for the first nine months of 2004.
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. The
significant lag between the timing of loan rate increases and increases in the
Bank's cost of funds is coming to an end. Management believes that the internal
lending rate may stabilize in the near future and that deposit rates may
continue to go up for a period of time. If this happens it is likely that there
will be some compression in the Company'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 third quarter ended September 30, 2005 and 2004 is
in the table below.
-20-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three months ended September 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 $ 4,787,602 $ 39,953 3.34% $ 222,444 $ 626 1.13%
Securities (including FHLB stock)(1) 19,750,698 205,055 4.15 16,835,080 158,350 3.76
Loans(2) 187,909,232 3,334,559 7.10 164,041,072 2,451,752 5.98
------------ ---------- ------ ------------ ---------- ------
212,447,532 3,579,577 6.74 181,098,596 2,610,728 5.77
Other assets 7,653,475 6,550,480
------------ ------------
$220,101,007 $187,649,076
============ ============
Liabilities and Shareholders' Equity
Interest bearing deposits $168,883,952 $1,260,477 2.99 $137,027,542 $ 784,030 2.29
Federal funds purchased and
repurchase agreements 7,688,902 43,535 2.26 13,586,778 48,617 1.43
Note Payable and Federal Home
Loan Bank Advances 10,500,000 151,781 5.78 8,952,717 127,327 5.69
------------ ---------- ------ ------------ ---------- ------
187,072,854 1,455,793 3.11 159,567,037 959,974 2.41
---------- ---------- ------
Non-interest bearing deposits 17,780,466 14,480,870
Other liabilities 957,733 641,680
Shareholders' Equity 14,289,954 12,959,489
------------ ------------
$220,101,007 $187,649,076
============ ============
Net interest income (tax equivalent basis) 2,123,784 1,646,043
Net interest spread on earning assets (tax
equivalent basis) 3.63% 3.36%
====== ======
Net interest margin on earning assets (tax
equivalent basis) 4.00% 3.65%
====== ======
Average interest-earning assets to Average
interest-bearing liabilities 113.56% 113.49%
====== ======
Tax equivalent adjustment 23,489 4,711
---------- ----------
Net interest income $2,100,295 $1,646,043
========== ==========
An analysis of the net interest income shows that the Bank had $31.3 million
more earning assets (mostly loans) on its books at the end of September 2005 as
compared to the similar quarter in 2004 and as a result was able to increase
interest income. Additionally, the interest expense paid on interest bearing
liabilities increased. Nonetheless, the movements were not dollar for dollar and
net interest income improved by $454,000. As a result of this positive outcome,
there was an increase in the Bank's net interest margin of 35 basis points. The
main contributing factors are the higher prime lending rate between the two
periods above and the lag in the repricing of deposits. A 201 basis point
difference in the average prime lending rate existed between the two periods.
- ----------
(1) Adjusted to fully tax equivalent basis
(2) Includes loans held for sale and non-accrual loans.
-21-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
As increases in the internal prime rate and increased 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 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
September 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 $ 54,718 $ 0 $ 0 $ 0 $ 54,718
Federal funds sold 3,150,000 0 0 0 3,150,000
Securities (including FHLB stock) 1,122,534 3,133,229 9,542,146 5,637,155 19,435,064
Loans 108,074,567 12,073,533 62,433,348 4,681,366 187,262,814
------------ ------------ ----------- ----------- ------------
112,401,819 15,206,762 71,975,494 10,318,521 209,902,596
Interest-bearing liabilities
Savings and checking 58,083,800 0 0 0 58,083,800
Time deposits <$100,000 716,361 14,841,682 11,014,596 5,415 26,578,054
Time deposits >$100,000 14,465,601 30,573,274 38,673,475 0 83,712,350
Repurchase agreements and
Federal funds purchased 6,895,716 0 0 0 6,895,716
Notes payable and Federal Home
Loan bank advances 10,500,000 0 0 0 10,500,000
------------ ------------ ----------- ----------- ------------
90,661,478 45,414,956 49,688,071 5,415 185,769,920
Net asset (liability) repricing gap $ 21,740,341 $(30,208,194) $22,287,423 $10,313,106 $ 24,132,676
============ ============ =========== =========== ============
Cumulative net asset (liability)
Repricing gap $ 21,740,341 $ (8,467,853) $13,819,570 $24,132,676
============ ============ =========== ===========
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
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 September 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
significant 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.
The provision for loan losses for the third quarter and the first nine months of
2005 were $98,000 and $346,000 compared to figures of $182,000 and $398,000 for
the same periods in 2004. During the third quarter of 2005 net new loans booked
were $536,000 compared to a net increase in loans of $4.1 million for the
similar period in 2004. In addition to differences in the volume of loans, there
was also $146,000 less net charge offs between the third quarter of 2005 and the
similar quarter in 2004. These two factors contributed to the differences in the
provision expense between the two quarterly periods.
The nine-month provision for loan losses also declined between 2004 and 2005.
Although the loan growth experienced between the two nine month periods was
similar, the level of net charge-offs between the two periods was not. There
were $89,000 more net charge-offs in the first nine months of 2004 than what was
experienced in 2005. The provision may be increased or decreased in the future
as management continues to monitor the loan portfolio and actual loan loss
experience. Management believes that the allowance level is adequate and
justifiable based on the factors discussed earlier (see Financial Condition) but
will continue to review the allowance with the intent of maintaining it at an
appropriate level.
Non-interest income recorded in the third quarter and first nine months of 2005
totaled $319,000 and $924,000 respectively. These figures represented increases
of 35% and 27% compared to the same periods in 2004. The main underlying factor
was the increase in service charge income. The expansion in reported service
charge income represented 92% of the growth in non-interest income.
Additional non-sufficient funds charges are the driving force behind the overall
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 may be
honored and a service charge may be automatically assessed. All three quarters
of 2005 were 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.
On a year to date basis, mortgage loan referral fees and gain on loan sales
totaled $28,000 compared to $68,000 being recorded through September 30 of 2004,
a decrease of 59%. As
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
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 over the past two years. Management feels that the
Bank is not overly dependent on mortgage fees and that in spite of increased
rates, there should continue to be a core amount of business derived from new
customers and new home purchases. However, the unfavorable comparison from this
source of non-interest income is likely to continue into the fourth quarter of
2005.
There were no security sales in the first three quarters of 2005. During the
first quarter 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 $49,000 for the first nine months of 2005
compared to the first three quarters of 2004. Other non-interest income totaled
$226,000 through September 30, 2005. The improvement of 28% is mostly related to
two categories. Brokerage commissions increased $26,000 and debit card fees
increased $25,000. A large portion of the increase in debit card fee income is
from business customers. A business debit card product was introduced in the
third quarter of 2004. The product has gained momentum since March of this year.
Non-interest expenses for the first nine months of 2005 were $5.0 million
compared to a total of $4.2 million for 2004, an increase of 18%. The third
quarter non-interest expense total was $1.8 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 other expenses.
On average there were an additional 7.0 full-time equivalent employees between
the same nine month period in 2005 and that of 2004. These staff additions,
merit increases in the salaries of existing staff members and additional earned
incentive payouts resulted in an increase to salaries and benefits expense of
15%. Additions to staff are made to support the growth of the Bank from both a
sales and operational standpoint. The $369,000 increase in salaries and benefits
between the first nine months of 2005 and the similar period in 2004 accounts
for 48% of the increase in total non-interest expenses.
Advertising expense was $118,000 in the first three quarters of 2005, an
increase of $74,000 over advertising expense in the first nine months of 2004.
The Bank initiated a significant newspaper campaign throughout a large portion
of the year in an attempt to attract local deposits to support anticipated and
experienced loan growth. Additionally the Bank instituted an image campaign
throughout its marketplace utilizing billboards and other media. Management
expects to continue both programs over the next two years due to the branching
initiatives that are expected to be completed during 2006.
The line item showing other non-interest expenses for the first nine months of
2005 has increased $226,000 (31%) 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,
Overdraft Privilege vendor fees, and state tax expenses.
-24-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
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 $18,000 from the first nine month period of 2005 compared to
that of 2004. Along this same vein, the Bank is in the process of redesigning
its marketing materials to promote a consistent brand identity across all
product lines. These expenses have totaled $17,000 so far in 2005.
Dues and subscriptions increased $34,000 in the first three quarters of 2005
compared to the similar period in 2004. $27,000 of the total was fees associated
with joining the 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 other
similar third party vendor expenses represent another $60,000 of the total
increase in other non interest expenses.
Federal tax expense has grown $283,000 due to dramatic increases in pre-tax
income. The effective tax rate for the first nine months of 2005 and that of
2004 was 33% and 34%. As a result of the favorable tax treatment of municipal
bonds, the Bank has been able to reduce its effective tax rate by increasing its
municipal bond holdings.
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 September 30, 2005. Based on the evaluation, our Chief
Executive Officer and Chief Financial Officer have concluded that the Company's
disclosure controls and procedures were, to the best of their knowledge,
effective as of September 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.
-25-
COMMUNITY SHORES BANK CORPORATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On July 19, 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.
On August 1, 2005, the Company issued and sold 2,000 shares of its common stock
to a director upon her exercise of a director stock option issued to her 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
Not applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
(a) Exhibits:
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- -------------------
3.1 Articles of Incorporation 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 Fee for Directors.
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COMMUNITY SHORES BANK CORPORATION
10.2 Purchase Agreement between Community Shores Bank and
Baumgardner-Hogan Real Estate, LLC is incorporated by reference to
exhibit 10.1 of the Company's Form 8-K dated November 2, 2005 (SEC
file number 000-51166).
10.3 Purchase Agreement between Community Shores Bank and Willamsburg
Court Apartments, LLC is incorporated by reference to exhibit 10.1
of the Company's Form 8-K dated November 9, 2005 (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 November 14, 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 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 Fee for Directors.
10.2 Purchase Agreement between Community Shores Bank and
Baumgardner-Hogan Real Estate, LLC is incorporated by reference to
exhibit 10.1 of the Company's Form 8-K dated November 2, 2005 (SEC
file number 000-51166).
10.3 Purchase Agreement between Community Shores Bank and Willamsburg
Court Apartments, LLC is incorporated by reference to exhibit 10.1
of the Company's Form 8-K dated November 9, 2005 (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-