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, 2006
[ ] 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
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 by
Rule 12-b2 of the Exchange Act).
Yes No X
----- -----
At October 31, 2006, 1,466,800 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................ 16
Item 3. Controls and Procedures............................. 28
PART II. Other Information
Item 1. Legal Proceedings................................... 28
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds............................................ 28
Item 3. Defaults upon Senior Securities..................... 28
Item 4. Submission of Matters to a Vote of Security
Holders............................................. 28
Item 5. Other Information................................... 29
Item 6. Exhibits............................................ 29
Signatures.................................................. 30
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30, December 31,
2006 2005
------------- ------------
(unaudited)
ASSETS
Cash and due from financial institutions $ 4,134,507 $ 4,361,277
Interest-bearing deposits in other financial institutions 54,455 90,182
Federal funds sold 450,000 200,000
------------ ------------
Cash and cash equivalents 4,638,962 4,651,459
Securities
Available for sale (at fair value) 13,096,118 13,983,933
Held to maturity (fair value of $5,222,999 at September
30, 2006 and $4,822,327 at December 31, 2005) 5,261,103 4,918,499
------------ ------------
Total securities 18,357,221 18,902,432
Loans 205,040,775 192,644,742
Less: Allowance for loan losses 2,546,827 2,612,581
------------ ------------
Net loans 202,493,948 190,032,161
Federal Home Loan Bank stock 411,500 425,000
Premises and equipment, net 8,431,199 5,922,886
Accrued interest receivable 1,105,749 994,219
Other assets 2,938,675 1,238,194
------------ ------------
Total assets $238,377,254 $222,166,351
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Non-interest bearing $ 17,810,068 $ 16,564,735
Interest bearing 187,645,924 173,886,366
------------ ------------
Total deposits 205,455,992 190,451,101
Federal funds purchased and repurchase agreements 5,026,652 6,065,010
Federal Home Loan Bank advances 6,000,000 6,000,000
Subordinated debentures 4,500,000 4,500,000
Notes Payable 400,000 0
Accrued expenses and other liabilities 1,126,753 650,329
------------ ------------
Total liabilities 222,509,397 207,666,440
Shareholders' equity
Common stock, no par value; 9,000,000 shares authorized;
September 30, 2006 1,466,800 and December 31, 2005
1,436,800 shares issued 13,274,098 12,998,670
Retained Earnings 2,781,193 1,712,462
Accumulated other comprehensive loss (187,434) (211,221)
------------ ------------
Total shareholders' equity 15,867,857 14,499,911
------------ ------------
Total liabilities and shareholders' equity $238,377,254 $222,166,351
============ ============
See accompanying notes to consolidated financial statements.
-1-
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September September September September
30, 2006 30, 2005 30, 2006 30, 2005
------------ ------------ ----------- -----------
Interest and dividend income
Loans, including fees $4,098,809 $3,334,559 $11,468,639 $9,255,802
Securities and FHLB dividends 181,241 181,576 541,281 512,293
Federal funds sold and other income 7,095 39,953 126,834 57,225
---------- ---------- ----------- ----------
Total interest income 4,287,145 3,556,088 12,136,754 9,825,320
Interest expense
Deposits 1,833,631 1,260,477 5,050,865 3,171,853
Repurchase agreements, federal funds purchased,
and other debt 107,957 43,535 218,640 171,988
Federal Home Loan Bank advances and notes payable 181,588 151,781 515,328 434,889
---------- ---------- ----------- ----------
Total interest expense 2,123,176 1,455,793 5,784,833 3,778,730
---------- ---------- ----------- ----------
NET INTEREST INCOME 2,163,969 2,100,295 6,351,921 6,046,590
Provision for loan losses 216,873 98,300 518,625 346,057
---------- ---------- ----------- ----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,947,096 2,001,995 5,833,296 5,700,533
Noninterest income
Service charges on deposit accounts 239,155 236,699 733,444 670,202
Mortgage loan referral fees 0 5,752 1,437 7,872
Net gain on sale of loans 124,610 3,717 141,013 20,152
Net gain (loss) on disposition of equipment 0 11,578 (124) 11,925
Other 97,015 72,336 261,250 225,552
---------- ---------- ----------- ----------
Total noninterest income 460,780 330,082 1,137,020 935,703
Noninterest expense
Salaries and employee benefits 992,048 991,226 2,930,124 2,740,725
Occupancy 100,828 83,086 275,902 231,484
Furniture and equipment 113,069 105,501 311,323 285,395
Advertising 90,778 32,058 174,570 118,485
Data processing 93,185 86,884 289,463 265,622
Professional services 166,603 131,219 424,394 396,528
Other 329,173 336,927 1,026,462 965,572
---------- ---------- ----------- ----------
Total noninterest expense 1,885,684 1,766,901 5,432,238 5,003,811
---------- ---------- ----------- ----------
INCOME BEFORE FEDERAL INCOME TAXES 522,192 565,176 1,538,078 1,632,425
Federal income tax expense 159,045 175,860 469,347 538,457
---------- ---------- ----------- ----------
NET INCOME $ 363,147 $ 389,316 $ 1,068,731 $1,093,968
========== ========== =========== ==========
Comprehensive income $ 496,307 $ 341,104 $ 1,092,518 $ 969,791
========== ========== =========== ==========
Weighted average shares outstanding 1,449,191 1,435,757 1,440,976 1,433,304
========== ========== =========== ==========
Diluted average shares outstanding 1,476,893 1,480,317 1,471,044 1,468,214
========== ========== =========== ==========
Basic earnings per share $ 0.25 $ 0.27 $ 0.74 $ 0.76
========== ========== =========== ==========
Diluted earnings per share $ 0.25 $ 0.26 $ 0.73 $ 0.75
========== ========== =========== ==========
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, 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 0 969,791
--------- ----------- ---------- --------- -----------
BALANCE, SEPTEMBER 30, 2005 1,436,800 $12,991,918 $1,593,751 $(146,940) $14,438,729
========= =========== ========== ========= ===========
BALANCE AT JANUARY 1, 2006 1,436,800 $12,998,670 $1,712,462 $(211,221) $14,499,911
Proceeds from the exercise of stock options 40,000 400,000 400,000
Stock tendered for option exercises (10,000) (125,900) (125,900)
Stock option compensation expense 1,328 1,328
Comprehensive income:
Net income 1,068,731 1,068,731
Unrealized gain (loss) on
securities available-for-sale, net 23,787 23,787
-----------
Total comprehensive income 1,092,518
--------- ----------- ---------- --------- -----------
BALANCE AT SEPTEMBER 30, 2006 1,466,800 $13,274,098 $2,781,193 $(187,434) $15,867,857
========= =========== ========== ========= ===========
See accompanying notes to consolidated financial statements.
-3-
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASHFLOW
(UNAUDITED)
Nine Months Nine Months
Ended Ended
September 30, 2006 September 30, 2005
------------------ ------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 1,068,731 $ 1,093,968
Adjustments to reconcile net income to net cash
from operating activities
Provision for loan losses 518,625 346,057
Depreciation and amortization 217,331 221,589
Net amortization of securities 21,357 24,604
Net realized gain on sale of loans (141,013) (20,152)
Net realized gain (loss) on disposition of equipment 124 (11,925)
Stock option compensation expense 1,328 0
Loans originated for sale (2,766,245) (2,569,050)
Proceeds from loan sales 2,907,257 2,589,202
Net change in:
Accrued interest receivable and other assets (1,824,265) (195,991)
Accrued expenses and other liabilities 476,424 146,619
------------- -------------
Net cash from operating activities 479,654 1,624,921
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in available-for-sale securities:
Maturities, prepayments and calls 2,159,546 1,756,322
Purchases (1,247,388) 0
Activity in held-to-maturity securities
Maturities 185,000 105,000
Purchases (537,262) (4,153,795)
Loan originations and payments, net (12,980,412) (16,002,745)
Redemption of Federal Home Loan Bank stock 13,500 0
Net additions to premises and equipment (2,725,768) (2,284,148)
------------- -------------
Net cash used in investing activities (15,132,784) (20,579,366)
CASH FLOW FROM FINANCING ACTIVITIES
Net change in deposits 15,004,891 27,260,770
Net change in federal funds purchased and
repurchase agreements (1,038,358) (3,085,062)
Draw on note payable 600,000 0
Paydown on note payable (200,000) 0
Net proceeds from the exercise of stock options 274,100 69,604
------------- -------------
Net cash from financing activities 14,640,633 24,245,312
------------- -------------
Net change in cash and cash equivalents (12,497) 5,290,867
Beginning cash and cash equivalents 4,651,459 2,375,615
------------- -------------
ENDING CASH AND CASH EQUIVALENTS $ 4,638,962 $ 7,666,482
============= =============
Supplemental cash flow information:
Cash paid during the period for Interest $ 5,599,930 $ 3,740,107
Cash paid for federal income tax $ 340,000 $ 735,000
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 nine months ended September 30, 2006 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, 2006 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,
2005. Some items in the prior year financial statements were reclassified
to conform to the current presentation.
In June 2006, the FASB issued Interpretation No. 48, Accounting for
Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109
(FIN 48), which clarifies the accounting for uncertainty in income taxes
recognized in a company's financial statements in accordance with SFAS 109,
Accounting for Income Taxes. FIN 48 prescribes a recognition and
measurement threshold for a tax position taken or expected to be taken in a
tax return. FIN 48 also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and
transition. FIN 48 is effective for fiscal years beginning after December
15, 2006. The Company has not completed its evaluation of the impact of the
adoption of FIN 48.
In September 2006, the Securities and Exchange Commission released Staff
Accounting Bulletin (SAB) 108. This SAB provides detailed guidance to
registrants in the determination of what is material to their financial
statements. This SAB is required to be applied to financial statements
issued after November 15, 2006. Upon adoption, the cumulative effect of
applying the new guidance is to be reflected as an adjustment to opening
retained earnings as of the beginning of the current fiscal year. The
Company has not completed its evaluation of the impact of SAB 108.
2. STOCK COMPENSATION
Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standard No. 123(R), Accounting for Stock-Based Compensation
("123(R)"), and has included the stock-based employee compensation expense
in its income statement for the nine months ended September 30, 2006. Prior
periods have not been restated.
-5-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2. STOCK COMPENSATION (Continued)
Options to buy stock were granted to officers under the Company's 1998
Employee Stock Option Plan ("the 1998 Employee Plan"), which provided for
issue of options for up to 150,000 shares of stock of the Company. The 1998
Employee Plan expired on September 1, 2003. While active, the 1998 Employee
Plan stipulated an exercise price of no less than the market price at the
date of grant and vesting over three years.
On May 12, 2005, the shareholders approved both the 2005 Employee Stock
Option Plan ("the 2005 Employee Plan") and the 2005 Director Stock Option
Plan ("the 2005 Director Plan"). Details of the individual plans are
included in the table below.
2005 Employee Plan 2005 Director Plan
---------------------------------------------- ----------------------------------------------
Shares authorized 53,000 20,000
Qualification as incentive plan Yes No
Option Price Not less than fair market value on the date of Not less than fair market value on the date of
grant grant
Vesting period 25% immediately and 25% on the next three Immediate
anniversaries (as determined by the Board of
Directors)
Expiration Up to 10 years from grant date Up to 10 years from grant date
On December 12, 2005, the Director Stock Option Committee of the Board of
Directors granted options for 2,000 shares to each of the nine non-employee
directors on the Company's Board. Each option has an exercise price of
$14.54 per share, which was the fair market value of the Company's common
stock as of the grant date. There are options for 2,000 shares left to be
granted.
As of September 30, 2006, no awards have been issued under the 2005
Employee Plan. Upon exercise of stock options, the Company issues new
shares from its authorized but unissued shares.
There was no vesting activity during the quarter as all issued options were
vested by June 30, 2006.
Activity in issued but unvested options year to date was as follows:
Weighted Avg
Shares Exercise Price
------ --------------
Issued and unvested as of December 31, 2005 281 $10.28
Shares vested during the period (281) 10.28
---- ------
Issued and unvested as of September 30, 2006 0 0.00
The fair value of options vested in the first nine months of 2006 was
$1,328.
-6-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2. STOCK COMPENSATION (Continued)
The fair value was computed using the following assumptions, which were
determined as of the grant date:
2003
------
Risk-free interest rate 3.61%
Expected option life 7 yrs
Expected stock price volatility 36.22%
Dividend yield 0.00%
Computed fair value per share $ 4.72
Compensation costs for all option plans were as follows:
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
2006 2005 2006 2005
---- ---- ---- ----
Compensation cost recognized
in income $0 $0 $1,328 $0
Related tax benefit recognized 0 0 0 0
Below is the activity under all plans for the three and nine month periods
ended September 30, 2006:
Three months ended
September 30, 2006
Total options outstanding
----------------------------
Wtd Avg Wtd Avg
Exercise Fair
Shares Price Value
------- -------- -------
Options outstanding, beginning of period 155,775 $10.55 $ 3.65
Forfeited 0 0 0
Exercised 40,000 $10.00 $ 2.76
Granted 0 0 0
------- ------ ------
Options outstanding, end of period 115,775 $10.74 $ 3.92
Options exercisable, end of period 115,775 $10.74 $ 3.92
Nine months ended
September 30, 2006
Total options outstanding
----------------------------
Wtd Avg Wtd Avg
Exercise Fair
Shares Price Value
------- -------- -------
Options outstanding, beginning of period 155,775 $10.55 $3.65
Forfeited 0 0 0
Exercised 40,000 $10.00 $2.76
Granted 0 0 0
------- ------ -----
Options outstanding, end of period 115,775 $10.74 $3.92
Options exercisable, end of period 115,775 $10.74 $3.92
The intrinsic value of options outstanding and options exercisable at
September 30, 2006 was $199,130.
-7-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2. STOCK COMPENSATION (Continued)
The following table illustrates the effect on net income and earnings per
share for the three month and nine month periods ending September 30, 2005
if expense had been measured using the fair value recognition provisions of
FASB Statement No. 123, Accounting for Stock-Based Compensation. The 2006
results are already inclusive of FASB Statement No. 123.
Three months ended Nine months ended
September 30, September 30,
------------------- -----------------------
2006 2005 2006 2005
-------- -------- ---------- ----------
Net income as reported $363,147 $389,316 $1,068,731 $1,093,968
Less: Value determined under fair value based
method (net of taxes) 0 2,311 1,328 6,933
Amount expensed in the period (net of taxes) 0 0 (1,328) 0
-------- -------- ---------- ----------
Pro forma net income $363,147 $387,005 $1,068,731 $1,087,035
======== ======== ========== ==========
Basic earnings per share as reported $ 0.25 $ 0.27 $ 0.74 $ 0.76
Pro forma basic earnings per share $ 0.25 $ 0.27 $ 0.74 $ 0.76
Diluted earnings per share as reported $ 0.25 $ 0.26 $ 0.73 $ 0.75
Pro forma diluted earnings per share $ 0.25 $ 0.26 $ 0.73 $ 0.74
3. SECURITIES
The following tables represent the securities held in the Company's
portfolio at September 30, 2006 and at December 31, 2005:
Gross Gross
Amortized Unrealized Unrealized Fair
September 30, 2006 Cost Gains Losses Value %
- ------------------ ---------- ---------- ---------- ----------- ----
Available for sale:
US Government and federal agency $7,459 $(111,455) $ 4,919,124 26.8
Municipal securities 4,890 (4,605) 706,771 3.8
Mortgage-backed securities 5,869 (186,149) 7,470,223 40.7
------- --------- ----------- ----
$18,218 $(302,209) $13,096,118 71.3
Held to maturity:
Municipal securities $5,261,103 $ 6,161 $ (44,265) $ 5,222,999 28.7
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2005 Cost Gains Losses Value %
- ------------------ ---------- ---------- ---------- ----------- ----
Available for sale:
US Government and federal agency $ 0 $(166,450) $ 5,360,898 28.4
Municipal securities 6,009 (7,928) 706,641 3.7
Mortgage-backed securities 5,953 (157,616) 7,916,394 41.9
------- --------- ----------- ----
11,962 (331,994) 13,983,933 74.0
Held to maturity:
Municipal securities $4,918,499 2,327 (98,499) 4,822,327 26.0
-8-
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,
2006:
Held to Maturity
-----------------------
Available for Sale Amortized Fair
Fair Value Cost Value
------------------ ---------- ----------
Due in one year or less $ 2,844,260 $ 0 $ 0
Due from one to five years 2,660,769 928,681 924,279
Due in more than five years 120,866 4,332,422 4,298,720
Mortgage-backed 7,470,223 0 0
----------- ---------- ----------
$13,096,118 $5,261,103 $5,222,999
=========== ========== ==========
4. LOANS
The components of the outstanding balances, their percentage of the total
portfolio and the percentage increase from the end of 2005 to September 30,
2006 were as follows:
Percent
September 30, 2006 December 31, 2005 Increase/
Balance % Balance % (Decrease)
------------ ----- ------------ ----- ----------
Commercial $ 89,486,083 43.6% $ 85,883,914 44.6% 4.19%
Real Estate:
Commercial 76,651,117 37.4 68,445,169 35.5 11.99
Residential 9,945,784 4.9 9,366,098 4.9 6.19
Construction 1,520,152 0.7 1,636,526 0.8 (7.11)
Consumer 27,581,916 13.4 27,445,727 14.2 0.50
------------ ----- ------------ -----
Gross loans 205,185,052 100.0 192,777,434 100.0 6.43
===== =====
Less: allowance for loan losses (2,546,827) (2,612,581)
Net deferred loan fees (144,277) (132,692)
------------ ------------
Net loans $202,493,948 $190,032,161
============ ============
-9-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS
The following is a summary of activity in the allowance for loan losses
account for the three and nine month periods ended September 30, 2006 and
2005:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
09/30/06 09/30/05 09/30/06 09/30/05
------------ ------------ ----------- -----------
Beginning Balance $2,436,765 $2,154,519 $2,612,581 $2,039,198
Charge-offs
Commercial (80,130) (21,616) (460,737) (85,166)
Real estate-commercial -- -- -- --
Real estate-residential -- -- -- --
Real estate-construction -- -- -- --
Consumer (31,834) (40,704) (176,214) (137,401)
---------- ---------- ---------- ----------
Total Charge-offs (111,964) (62,320) (636,951) (222,567)
Recoveries
Commercial 1,607 -- 9,527 --
Real estate-commercial -- -- -- --
Real estate-residential -- -- -- --
Real estate-construction -- -- -- --
Consumer 3,546 3,623 43,045 31,434
---------- ---------- ---------- ----------
Total Recoveries 5,153 3,623 52,572 31,434
Provision for loan losses 216,873 98,300 518,625 346,057
---------- ---------- ---------- ----------
Ending Balance $2,546,827 $2,194,122 $2,546,827 $2,194,122
========== ========== ========== ==========
6. PREMISES AND EQUIPMENT
Period end premises and equipment were as follows:
September 30, December 31,
2006 2005
------------- ------------
Land & land improvements $ 3,744,028 $3,744,028
Buildings & building improvements 1,693,410 1,689,664
Furniture, fixtures and equipment 2,046,905 2,245,604
Construction in Process 2,902,054 273,738
----------- ----------
10,386,397 7,953,034
Less: accumulated depreciation 1,955,198 2,030,148
----------- ----------
$ 8,431,199 $5,922,886
=========== ==========
-10-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. DEPOSITS
Deposit balances increased $15,004,891 since December 31, 2005. The
components of the outstanding balances, their percentage of the total
portfolio and the percentage increase from the end of 2005 through
September 30, 2006 were as follows:
September 30, 2006 December 31, 2005 Percent
-------------------- -------------------- Increase/
Balance % Balance % (Decrease)
------------ ----- ------------ ----- ----------
Non-interest bearing
Demand $ 17,810,068 8.7% $ 16,564,735 8.7% 7.5%
Interest bearing
Checking 21,145,622 10.3 23,465,273 12.3 (9.9)
Money Market 19,023,100 9.3 17,408,588 9.1 9.3
Savings 12,613,135 6.1 14,432,484 7.6 (12.6)
Time, under $100,000 35,396,413 17.2 28,922,830 15.2 22.4
Time, over $100,000 99,467,654 48.4 89,657,191 47.1 10.9
------------ ----- ------------ -----
Total Deposits $205,455,992 100.0% $190,451,101 100.0%
============ ===== ============ =====
8. SHORT-TERM BORROWINGS
At both September 30, 2006 and December 31, 2005, the Company's short-term
borrowings were made up of repurchase agreements only. The September 30,
2006 and December 31, 2005 information was as follows:
Repurchase Federal Funds
Agreements Purchased
----------- -------------
Outstanding at September 30, 2006 $ 5,026,652 $ 0
Average interest rate at period end 3.35% 0.00%
Average balance during period 4,908,560 2,580,385
Average interest rate during period 3.08% 5.44%
Maximum month end balance during period 5,205,503 6,700,000
Outstanding at December 31, 2005 $ 6,065,010 $ 0
Average interest rate at year end 2.83% 0.00%
Average balance during year 7,757,732 3,157,507
Average interest rate during year 1.88% 3.42%
Maximum month end balance during year 10,776,372 10,600,000
-11-
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 $7,003,440.
Each borrowing requires a direct pledge of securities or loans. At
September 30, 2006, the Bank had assets with a market value of $9,711,257
pledged to the Federal Home Loan Bank to support current borrowings.
Details of the Bank's outstanding borrowings at both September 30, 2006 and
December 31, 2005 are:
Current September 30, December 31,
Maturity Date Interest Rate 2006 2005
------------- ------------- ------------- ------------
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 was
7.421630% at September 28, 2006. 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 or about March 30th, June
30th, September 30th and December 30th.
The most recent distribution was paid on October 2, 2006, which was the
first business day following September 30, 2006. 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. NOTES PAYABLE
The Company has a $5 million revolving line of credit with LaSalle Bank
National Association ("LaSalle"). The total balance outstanding at
September 30, 2006 was $400,000. There was no balance on the line at
December 31, 2005. The Company made three draws of $200,000 during the
first nine months of the year, one in each quarter. During the third
quarter, the Company made a payment of $200,000 using proceeds received
from employee stock option exercises. The outstanding principal bears
interest at a rate of 90 basis points below LaSalle's prime rate, which is
currently 8.25%. Interest is owed quarterly in arrears on the first
business day of February, May, August, and November until the principal of
this note is paid. The borrowings may be
-12-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
11. NOTES PAYABLE (Continued)
prepaid in whole or in part without any prepayment penalty. The proceeds
were essentially used for the general operating expenses of the Company.
12. 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
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, 2006 and
December 31, 2005 follows:
September 30, December 31,
2006 2005
------------- ------------
Unused lines of credit and letters of credit $38,261,604 $37,923,303
Commitments to make loans 62,300 271,127
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.
13. 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
-13-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
13. REGULATORY MATTERS (Continued)
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.
The required capital to risk-weighted assets and tier one capital to
average asset ratios for the first three capital classifications are as
follows:
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
Actual capital levels and minimum required levels at September 30, 2006 and
December 31, 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. 2006
Total Capital (Tier 1 and Tier 2)
to risk-weighted assets
Consolidated $23,102,118 10.46% $17,675,448 8.00% $22,094,310 N/A
Bank 23,171,183 10.49 17,671,970 8.00 22,089,963 10.00
Tier 1 (Core) Capital to risk
risk-weighted assets
Consolidated 20,555,291 9.30 8,837,724 4.00 13,262,586 N/A
Bank 20,624,356 9.34 8,835,985 4.00 13,253,978 6.00
Tier 1 (Core) Capital to
average assets
Consolidated 20,555,291 8.81 9,335,982 4.00 11,669,977 N/A
Bank 20,624,356 8.84 9,334,210 4.00 11,667,763 5.00
December 31. 2005
Total Capital (Tier 1 and Tier 2)
to risk weighted assets
Consolidated $21,746,410 10.73% $16,231,964 8.00% $20,289,955 N/A
Bank 21,683,639 10.70 16,230,267 8.00 20,287,834 10.00
Tier 1 (Core) Capital to risk
risk-weighted assets
Consolidated 19,211,132 9.48 8,115,982 4.00 12,173,973 N/A
Bank 19,148,629 9.44 8,115,134 4.00 12,172,700 6.00
Tier 1 (Core) Capital to
average assets
Consolidated 19,211,132 8.73 8,802,457 4.00 11,003,072 N/A
Bank 19,148,629 8.70 8,801,143 4.00 11,001,429 5.00
-14-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
13. REGULATORY MATTERS (Continued)
The Company and the Bank were in the well-capitalized category at both
September 30, 2006 and December 31, 2005. 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.
-15-
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, 2006 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, 2006 to that at December 31, 2005. The part labeled
Results of Operations discusses the three month and nine month periods ended
September 30, 2006 as compared to the same periods of 2005. 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 Form 10-QSB contain
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 $16.2 million to $238.4 million at September 30, 2006
from $222.2 million at December 31, 2005. This is a 7.3% increase in assets
during the first nine months of 2006. Asset growth was funded by deposit growth
and was mostly reflected by increases in the loan portfolio and premises and
equipment.
-16-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Total loans climbed to $205.0 million at September 30, 2006 from $192.6 million
at December 31, 2005. The $12.4 million net increase is primarily comprised of
$11.8 million growth in the commercial and commercial real estate portfolios.
The "wholesale" (commercial and commercial real estate) lending focus applied
since opening in 1999 continued during the first nine months of 2006. 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. Since
year-end 2005 two lenders have left the Bank to work for a local competitor. As
a result of the turnover, it is a possibility that the Bank may lose some
customers. To reduce the risk, the Bank has identified a list of potentially
vulnerable relationships and spent a significant amount of time visiting those
customers. In the third quarter, one new lender was recruited to replace one of
the open lending positions. It is the Bank's intention to retain existing
lending staff and attract another new lender to fill the remaining position
created by the turnover.
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, 2006 are included below:
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
----------- ----------- ------------ ----------- ------------
Commercial, financial and other $21,130,481 $29,683,339 $ 34,651,643 $ 3,876,343 $ 89,341,806
Real estate:
Commercial 9,112,198 8,434,896 57,806,632 1,297,391 76,651,117
Residential 65,011 218,023 1,348,056 8,314,694 9,945,784
Construction 1,036,038 484,114 -- -- 1,520,152
Installment loans to individuals 2,120,206 3,723,224 19,811,653 1,926,833 27,581,916
----------- ----------- ------------ ----------- ------------
$33,463,934 $42,543,596 $113,617,984 $15,415,261 $205,040,775
=========== =========== ============ =========== ============
Loans at fixed rates $ 5,648,935 $ 5,357,854 $ 85,016,133 $10,249,277 $106,272,199
Loans at variable rates 27,814,999 37,185,742 28,601,851 5,165,984 98,768,576
----------- ----------- ------------ ----------- ------------
$33,463,934 $42,543,596 $113,617,984 $15,415,261 $205,040,775
=========== =========== ============ =========== ============
At September 30, 2006, 52% of the loan balances carried a fixed rate, 48% a
floating rate and only 7.5% 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, 2006, the
allowance totaled $2.5 million or approximately 1.24% 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.
- ----------
(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.
-17-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Based on management's analysis, an additional $519,000 was added to the
allowance through provision for loan losses during the first nine months of 2006
with $217,000 being added in the third quarter.
The allocation of the allowance at September 30, 2006 was as follows:
September 30, 2006 December 31, 2005
-------------------------- ---------------------------
Percent of Percent of
Allowance Allowance
Balance at End of Period Applicable to: Related to Related to
Amount Loan category Amount Loan category
---------- ------------- ---------- --------------
Commercial $1,260,749 49.5% $1,460,911 55.9%
Real estate:
Commercial 915,029 35.9 777,331 29.8
Residential 49,729 2.0 46,830 1.8
Construction 17,482 0.7 18,820 0.7
Consumer 303,838 11.9 308,689 11.8
Unallocated 0 0.0 0 0.0
---------- ----- ---------- -----
Total $2,546,827 100.0% $2,612,581 100.0%
========== ===== ========== =====
The ratio of allowance for loan losses to total loans declined from a level of
1.36% at December 31, 2005 in spite of the net growth in the commercial and
commercial real estate loan portfolios. The main factor in the reduction was
that there were charge-offs totaling $637,000 in the first nine months of 2006.
Seventy five percent of the total principal charged off was related to one
commercial relationship. The allowance for loan losses at December 31, 2005
contained significant specific allocations for this relationship, increasing the
percent of allowance related to the commercial loan category and driving up the
overall ratio of allowance for loan losses to total loans at year-end. Once the
charge offs occurred, the percent of the allowance related to the commercial
loan category declined and so did the overall ratio of allowance for loan losses
to total loans. Conversely, there has been a significant increase in the
allowance allocated to commercial real estate loans. A majority of the increase
stems from the fact that 66% of the loan growth since December 31, 2005 has been
in the commercial real estate category.
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 September 30, 2006 compared to those at
year-end 2005 and the corresponding change, related to those two periods.
September 30, December 31, Increase
Loans Past Due: 2006 2005 (Decrease)
- --------------- ------------- ------------ -----------
30-59 days $972,000 $2,423,000 ($1,451,000)
60-89 days 314,000 159,000 155,000
90 days and greater 620,000 379,000 241,000
Non accrual notes 774,000 749,000 25,000
Since year-end 2005, overall past due and non-accrual loans have decreased by
$1.0 million. A majority of the decrease occurred in the 30-59 day category. The
elevated sum of loans in
-18-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
this past due category at year-end was caused by a multiplicity of minor
factors. Most of the improvement shown above had taken place by January 31,
2006.
Contrary to the decline in the 30-59 day past due category, loans past due 60-89
days increased between the two period ends. One relationship totaling 38% of
total loans past due 60-89 days is in the process of selling the underlying real
estate collateral and expects to pay the Bank off sometime in November. There is
minimal loss expected as a result of the transaction. On November 1, 2006,
another relationship comprising 24% of total loans past due 60-89 days,
developed a plan with the Bank's collection department to bring the loan
balances current prior to year-end.
Approximately 45% of the total loans past due 90 days and more is related to one
commercial credit. This customer was not past due at year-end 2005. The customer
is involved in the farming industry. At this time, the Bank has initiated the
foreclosure process. No significant losses are expected. The balances
outstanding are well collateralized by real estate.
Non-accrual loans increased minimally, $25,000, since December 31, 2005.
Although the collection process is believed to be sound, there was still the
need to charge-off loans. Annualized net charge-offs to average loans was 0.40%
for the first nine months of 2006, up significantly from 0.14% for the first
nine months of 2005. There were net charge-offs of $584,000 recorded for the
first nine months of 2006, which is higher than net charge-offs of $191,000 for
the similar period in 2005. Approximately 66% of the net charge-offs recorded in
2006 occurred in the first quarter. Over 61% of year to date charge-offs are
related to one commercial relationship.
Premises and equipment increased by a net figure of $2.5 million. The majority
of the increase is related to construction of two branches in the Muskegon area.
Both branches are scheduled to open in the next four months. The Bank is also in
the process of finalizing plans for construction of a branch in Grand Haven on
US 31. The construction is expected to begin in the fall and to be completed by
August 2007. The current Grand Haven banking location is leased. Finally, the
Bank purchased vacant land at Apple and Quarterline on the east side of Muskegon
on October 5, 2006. The purchase price was $721,000.
Other Assets rose by $1.7 million. A majority (68%) of the increase was a
receivable from an investor that had purchased a Small Business Administration
(SBA) loan prior to September 30 but had not yet remitted the proceeds.
The proceeds were received on October 3,2006.
Deposit balances were $205.5 million at September 30, 2006 up from $190.5
million at December 31, 2005. Total deposit growth since year-end was $15.0
million or 7.9%. The entire increase is made up of growth in time deposits. Time
deposits rose $16.3 million since year-end 2005. Time deposit totals include
both local and brokered deposits. Local time deposit balances grew $7.4 million
in the first nine months of 2006. This achievement is the result of consistently
advertised rate specials conducted locally in the newspaper and in the branches.
Brokered deposits made up 55% of the growth in time deposits during the first
three quarters of the year. 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 concentration of
-19-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
brokered deposits to local deposits has increased to 36% at September 30, 2006
from 35% at December 31, 2005. It is anticipated that the usage of brokered
deposits will taper over time once the branch network of the Bank expands.
The Bank had Federal Home Loan Bank ("FHLB") advances outstanding, totaling
$6,000,000, at both September 30, 2006 and December 31, 2005. The advances
consist of three separate notes, which are all putable advances. All three
instruments currently have rates ranging from 5.10% to 5.99%. All three notes
are eligible to convert to a floating rate index at the option of the FHLB (put
option). The option is contractually available to the FHLB once each quarter. If
the option is exercised, the advance will convert to a floating rate based on a
spread to LIBOR. In the event that the FHLB exercises its option and the note is
converted, the Bank has the opportunity to repay the advance at that time with
no pre-payment penalty. As borrowing rates continue to climb, it is a
possibility that the FHLB will exercise the put. The applicable LIBOR rates are
monitored every quarter by management to assess the likelihood of the FHLB
converting any of the three notes. Based on the most recent assessment, the Bank
believes that there may be a basis for expecting the FHLB to exercise its put
for one of the advances on the next call date, which is December 2006. The
principal balance outstanding on this particular advance is $2.5 million. The
scheduled maturities, if the notes are not paid prior to that, are all in 2010.
At both September 30, 2006 and December 31, 2005, the Company had $4.5 million
of subordinated debentures outstanding resulting from a pooled trust preferred
offering on December 17, 2004.
The notes payable balance consists of draws on the Company's revolving line of
credit with LaSalle. The balance increased $400,000 since December 31, 2005. In
each of the first three quarters of 2006, the Company made a $200,000 draw. In
August, the bank received cash from an employee stock option exercise and
remitted $200,000 to LaSalle to pay down principal. The proceeds in all cases
were used for general operating expenses of the Company. Future draws are
expected for similar reasons as well as for the purpose of contributing capital
to the Bank to maintain a regulatory well-capitalized status.
The shareholders' equity totaled $15.9 million and $14.5 million at September
30, 2006 and December 31, 2005 respectively. The increase is comprised of
increases to common stock as a result of a stock option exercise, earnings
recorded in the first nine months of 2006 and a reduction of accumulated other
comprehensive loss (security market value adjustments).
RESULTS OF OPERATIONS
The net income for the first nine months of 2006 was $1,069,000 a decrease of
$25,000 compared to net income of $1,094,000 recorded for the same time period
in 2005. The corresponding basic and diluted earnings per share for the first
nine months of 2006 were $0.74 and $0.73 respectively, and $0.76 and $0.75 for
2005.
Net income for the third quarter of 2006 was $363,000 while net income for the
similar period in 2005 was $389,000. The corresponding basic and diluted
earnings per share for the third
-20-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
quarter of 2006 was $0.25 which is slightly less than the basic earnings and
diluted earnings per share of $0.27 and $0.26 recorded for the same period
in 2005.
For both the first nine months and third quarter of 2006, the annualized return
on the Company's average total assets was 0.62%, which is down from 0.69% and
0.71% annualized return for the same periods in 2005. The Company's annualized
return on average equity was 9.42% and 9.33% for the first nine months and third
quarter of 2006 and 10.50% and 10.89% for the first nine months and third
quarter of 2005. The ratio of average equity to average assets was 6.60% and
6.67% for the first nine months and third quarter of 2006 and 6.59% and 6.49%
for the same periods in 2005.
Although the net earnings are similar for the third quarter and first nine
months of 2006 compared to the same periods in 2005, there are important
differences in the various categories of income and expense. One difference
between the operating results of the first nine months of 2005 and 2006 is the
net interest income and the corresponding 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.
-21-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Nine months ended September 30:
--------------------------------------------------------------------------------
2006 2005
--------------------------------------- --------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------------ ----------- ---------- ------------ ---------- ----------
Assets
Federal funds sold and interest-
bearing deposits with banks $ 3,720,311 $ 126,834 4.55% $ 2,509,265 $ 57,225 3.04%
Securities (including FHLB stock)(1) 19,430,919 621,798 4.27 18,522,144 555,022 4.00
Loans (2) 196,017,819 11,468,639 7.80 182,507,263 9,255,802 6.76
------------ ----------- ------ ------------ ---------- ------
219,169,049 12,217,271 7.43 203,538,672 9,868,049 6.46
Other assets 10,198,478 7,122,464
------------ ------------
$229,367,527 $210,661,136
============ ============
Liabilities and Shareholders' Equity
Interest bearing deposits $177,886,277 $ 5,050,865 3.79 $158,217,454 $3,171,853 2.67
Federal funds purchased and
repurchase agreements 7,488,944 218,640 3.89 11,194,854 171,988 2.05
Note Payable and Federal Home
Loan Bank Advances 10,704,396 515,328 6.42 10,500,000 434,889 5.52
------------ ----------- ------ ------------ ---------- ------
196,079,617 5,784,833 3.93 179,912,308 3,778,730 2.80
----------- ----------
Non-interest bearing deposits 17,564,795 16,074,574
Other liabilities 589,265 781,330
Shareholders' Equity 15,133,850 13,892,924
------------ ------------
$229,367,527 $210,661,136
============ ============
Net interest income (tax equivalent basis) 6,432,438 6,089,319
Net interest spread on earning assets (tax
equivalent basis) 3.50% 3.66%
====== ======
Net interest margin on earning assets (tax
equivalent basis) 3.91% 3.99%
====== ======
Average interest-earning assets to Average
interest-bearing liabilities 111.78% 113.13%
====== ======
Tax equivalent adjustment 80,517 42,729
----------- ----------
Net interest income $ 6,351,921 $6,046,590
=========== ==========
The tax equivalent net interest spread on average earning assets decreased 16
basis points to 3.50% since September 30, 2005. The tax equivalent net interest
margin decreased by 8 basis points from 3.99% at September 30, 2005 to 3.91% at
September 30, 2006. The tax equivalent net interest income for the first nine
months of 2006 was $6.4 million compared to a figure of $6.0 million for the
same nine months in 2005. Although the Company reported more total net interest
income there was net interest margin compression between the two periods.
Relative increases to loan income from higher internal prime lending rates and
more average loans outstanding were not as much as the increases in expense
experienced on the funding side from a rate and outstanding balance perspective.
The average rate earned on interest earning assets was 7.43% for the nine months
ended September 30, 2006 compared to 6.46% for the same period in 2005, a 97
basis point increase. The main contributing factor was a 104 basis point
increase in the yield on loans, the Bank's largest earning asset category.
Internal prime rate changes, no matter what direction,
- ----------
(1) Adjusted to fully tax equivalent basis.
(2) Includes loans held for sale and non-accrual loans.
-22-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
affect interest earned on variable rate loans and new loan volume. At September
30, 2006, 48% of the Bank's loan portfolio was variable compared to 60% at
September 30, 2005. A lower concentration of variable rate loans means that less
loans on the books were able to take advantage of the 193 basis point increase
in the average internal prime lending rate between the two periods.
Interest expense incurred on deposits, repurchase agreements, federal funds
purchased, Federal Home Loan Bank advances and Notes Payable increased by 113
basis points for the first nine months of 2006 compared to the first nine months
of 2005. During 2005, there was a significant lag between the timing of loan
rate increases and increases in the Bank's cost of funds. For the first nine
months of 2006, funding rates rose at a faster pace than increases to the rates
on earning assets. In fact, since December 2005, the average rate on cost of
funds rose 97 basis points or 16 basis points more than the increase on earning
assets. Management believes that stabilization of the prime lending rate could
cause further net interest margin compression since it is likely that deposit
rates would continue to rise for a period of time.
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, 2006 and 2005 is
in the table below.
-23-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three months ended September 30:
-------------------------------------------------------------------------------
2006 2005
-------------------------------------- --------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------------ ---------- ---------- ------------ ---------- ----------
Assets
Federal funds sold and interest-
bearing deposits with banks $ 566,559 $ 7,095 5.01% $ 4,787,602 $ 39,953 3.34%
Securities (including FHLB stock)(1) 19,201,745 208,480 4.34 19,750,698 205,065 4.15
Loans (2) 202,431,823 4,098,809 8.10 187,909,232 3,334,559 7.10
------------ ---------- ------ ------------ ---------- ------
222,200,127 4,314,384 7.77 212,447,532 3,579,577 6.74
Other assets 11,199,417 7,653,475
------------ ------------
$233,399,544 $220,101,007
============ ============
Liabilities and Shareholders' Equity
Interest bearing deposits $178,115,917 $1,833,631 4.12 $168,883,952 $1,260,477 2.99
Federal funds purchased and
repurchase agreements 9,636,852 107,957 4.48 7,688,902 43,535 2.26
Note Payable and Federal Home
Loan Bank Advances 10,828,261 181,588 6.71 10,500,000 151,781 5.78
------------ ---------- ------ ------------ ---------- ------
198,581,030 2,123,176 4.28 187,072,854 1,455,793 3.11
---------- ----------
Non-interest bearing deposits 18,377,412 17,780,466
Other liabilities 872,117 957,733
Shareholders' Equity 15,568,985 14,289,954
------------ ------------
$233,399,544 $220,101,007
============ ============
Net interest income (tax equivalent basis) 2,191,208 2,123,784
Net interest spread on earning assets (tax
equivalent basis) 3.49% 3.63%
====== ======
Net interest margin on earning assets (tax
equivalent basis) 3.94% 4.00%
====== ======
Average interest-earning assets to Average
interest-bearing liabilities 111.89% 113.56%
====== ======
Tax equivalent adjustment 27,239 23,489
---------- ----------
Net interest income $2,163,969 $2,100,295
========== ==========
Similar to the comparison of the net interest income results of the first nine
months of 2005 to that of the first nine months of 2006, there was an overall
increase in tax equivalent net interest income between the two three month
periods but there was net interest margin compression. Tax equivalent net
interest income improved by $67,000 but the tax equivalent net interest spread
and margin declined by 14 and 6 basis points respectively between the third
quarter of 2005 and the similar period in 2006. There was a 183 basis point
difference in the internal prime lending rate between the two periods.
Since escalating cost of funds appear probable and future prime rate changes, no
matter what direction, are unpredictable, asset liability management will
continue to be an important tool for assessing and monitoring interest rate
sensitivity and liquidity. 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 realizing reasonable and predictable earnings and
liquidity by maintaining a balance between interest-earning assets and
interest-bearing liabilities. Liquidity management
- ----------
(1) Adjusted to fully tax equivalent basis.
(2) Includes loans held for sale and non-accrual loans.
-24-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
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.
The Company uses a sophisticated computer program to assist with asset liability
management, model and measure interest rate sensitivity and perform analysis of
interest rate risk. 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, 2006 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 $ 54,455 $ 0 $ 0 $ 0 $ 54,455
Federal funds sold 450,000 0 0 0 450,000
Securities (including FHLB stock) 2,339,203 2,568,895 9,021,632 4,838,991 18,768,721
Loans (including held for sale) 105,743,940 12,384,883 80,482,536 6,429,416 205,040,775
------------ ------------ ----------- ----------- ------------
108,587,598 14,953,778 89,504,168 11,268,407 224,313,951
Interest-bearing liabilities
Savings and checking 52,781,859 0 0 0 52,781,859
Time deposits <$100,000 6,456,424 21,121,415 7,793,573 25,000 35,396,412
Time deposits >$100,000 9,979,485 42,523,687 46,964,481 0 99,467,653
Repurchase agreements and
Federal funds purchased 5,026,652 0 0 0 5,026,652
Notes payable and Federal Home
Loan bank advances 10,900,000 0 0 0 10,900,000
------------ ------------ ----------- ----------- ------------
85,144,420 63,645,102 54,758,054 25,000 203,572,576
Net asset (liability) repricing gap $ 23,443,178 $(48,691,324) $34,746,114 $11,243,407 $ 20,741,375
============ ============ =========== =========== ============
Cumulative net asset (liability)
Repricing gap $ 23,443,178 $(25,248,146) $ 9,497,968 $20,741,375
============ ============ =========== ===========
Currently the Company has a negative twelve month repricing gap which indicates
that the Company is liability sensitive in the next twelve month period. This
position implies that increases to the national federal funds rate would have
more of an impact on interest expense than on interest income during this period
if there were a parallel shift in rates. For instance if the Company's internal
prime rate went up by 25 basis points and every interest earning asset and
interest bearing liability on the Company's September 30, 2006 balance sheet
repricing 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.
-25-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
The provision for loan losses for the third quarter and the first nine months of
2006 were $217,000 and $519,000 compared to figures of $98,000 and $346,000 for
the same periods in 2005. 2005's expenses included a credit rating upgrade of a
significant commercial loan customer. This event allowed the removal of
specifically allocated reserves previously assigned to the loan. As a result, in
2005, the Bank was able to use the unallocated reserve to support a portion of
new loan growth. So although loan growth was similar in the first nine months of
2005 and 2006 the credit upgrade made the provision expense required between the
two periods look significantly different. Management believes that the allowance
level is adequate and justified 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 nine months of 2006 totaled $1.1
million and represented a 22% increase over last year's first nine month total,
which was $936,000. There were two primary factors responsible for the rise,
service charge income and gains on loan sales. The service charge income was
$63,000 higher in the first nine months of 2006 compared to the similar period
in 2005. Non-sufficient funds charges related to the Overdraft Privilege program
increased $91,000 but were offset by a decline in business account service
charges. Gains on loan sales totaled $141,000 in the first nine months of 2006
compared to $20,000 recorded for the similar period in 2005.
Late last year, the Bank recruited an experienced SBA lender to develop an
active SBA lending program. In the third quarter of 2006, the Bank implemented
its SBA lending program and was able to originate and sell two loans to various
investors for a realized gain of $121,000. The program as designed entails
originating SBA loans and selling the guaranteed portion(usually 75%-80%) to an
investor for a premium. The Bank intends on retaining the unguaranteed portion
of each sold loan and will receive a monthly servicing fee for processing
the loan payments. Management is optimistic about the SBA lending program and
its continued contributions to non-interest income.
Total non-interest income for the third quarter of 2006 rose $131,000 over that
which was recorded in the third quarter of 2005. The gains on loan sales
described above comprised 92% of the increase.
Non-interest expenses for the first nine months of 2006 were $5.4 million
compared to a total of $5.0 million for 2005, an increase of 9%. The third
quarter non-interest expense total was $1.9 million for 2006 and $1.8 million
for 2005.
Salaries and benefits for the third quarter of 2006 were essentially flat when
compared to the similar period in 2005. Conversely, the year to date totals for
salaries and benefits did increase by 6.9% to $2.9 million. On average there
were an additional 5.0 full-time equivalent employees between the same nine
month period in 2006 and that of 2005. These additions as well as general salary
increases resulted in an increased expense of $189,000. Some of the additions to
staff were for the Harvey Street Branch, which is scheduled to open on November
6, 2006. The increase in salaries and benefits between the first nine months of
2006 and the similar period in 2005 accounted for 44% of the increase in total
non-interest expenses.
-26-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Occupancy expenses were $276,000 for the first three quarters of 2006 compared
to $231,000 for the first three quarters of 2005. The increase of $44,000 was
attributable to expenses associated with getting out of our North Muskegon lease
early as well as higher property tax liabilities resulting from land purchases
in Norton Shores, North Muskegon and Grand Haven during 2005. The Bank intends
to operate a new full service branch at each of these sites. The Grand Haven and
North Muskegon branches are replacements of the spaces that are currently
leased. Each branch is in various stages of construction. As the branches become
functional the occupancy expenses are expected to increase from the additional
depreciation costs.
Advertising expenses of $175,000 were recorded for the first nine months of 2006
compared to $118,000 for the same period one year ago. The increase of $57,000
(48%) was mostly attributable to an enhanced marketing campaign. All of the year
to date increase was recorded in the third quarter. Advertising costs in the
third quarter of 2006 were $59,000 more than those recorded in 2005's third
quarter. Advertising costs are likely to escalate given the fact that there are
three branches scheduled to open in the next twelve months.
Professional services expenses were $167,000 for the third quarter of 2006,
which was an increase of $35,000 (27%) compared to the third quarter of 2005.
The increase is primarily related to legal fees associated with a matter
addressed late in the second quarter.
The line item showing other non-interest expenses for the first nine months of
2006 has increased $61,000 (6%) compared to the same period in 2005. The most
significant item supporting the increase was an upsurge in loan collection
expenses of $75,000 between the two periods. A substantial portion of the
increase is related to one impaired commercial relationship and the related
expenses incurred to liquidate the associated collateral.
The federal tax expense has decreased for both the third quarter and first nine
months of 2006 compared to the same periods in 2005. The decreases are related
to differences in tax free municipal bond holdings between the two period ends.
The effective tax rate for the first nine months and third quarter of 2006 was
31% and 30% compared to 33% and 31% for the first nine months and third quarter
of 2005.
-27-
COMMUNITY SHORES BANK CORPORATION
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, 2006. 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, 2006 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 August 24, 2006, the Company issued and sold 40,000 shares of its common
stock to a past employee upon his exercise of a stock option issued to him under
the Company's 1998 Employee Stock Option Plan. The Company received an exercise
price of $10.00 per share. The $400,000 exercise price for these shares was paid
by the employee delivering to the Company $274,100 in cash, and 10,000 shares of
common stock of the Company that he already owned having an aggregate value of
$125,900. The 40,000 shares issued upon exercise of the stock option 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
None.
-28-
COMMUNITY SHORES BANK CORPORATION
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(ii) of the Company's June 28, 2006 Form 8-K (SEC file number
000-51166).
10.1 Extension to the agreement between Fiserv Solutions, Inc. and
Community Shores Bank is incorporated by reference to exhibit 10.2
of the Company's July 7, 2006 Form 8-K (SEC File No. 000-51166).
10.2 Addendum #3 to the Buy and Sell Agreement with Baumgardner-Hogan
Real Estate, LLC is incorporated by reference to exhibit 10.1 of
the Company's July 11, 2006 Form 8-K (SEC File No. 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-
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, 2006.
COMMUNITY SHORES BANK CORPORATION
By: /s/ Heather D Brolick
-------------------------------------
Heather D. Brolick
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)
-30-
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(ii) of the Company's June 28, 2006 Form 8-K (SEC file number
000-51166).
10.1 Extension to the agreement between Fiserv Solutions, Inc. and
Community Shores Bank is incorporated by reference to exhibit 10.2
of the Company's July 7, 2006 Form 8-K (SEC File No. 000-51166).
10.2 Addendum #3 to the Buy and Sell Agreement with Baumgardner-Hogan
Real Estate, LLC is incorporated by reference to exhibit 10.1 of
the Company's July 11, 2006 Form 8-K (SEC File No. 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.
-31-