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, 2007
[ ] 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 Identification No.)
incorporation or organization)
1030 W. NORTON AVENUE, MUSKEGON, MICHIGAN 49441
(Address of principal executive offices)
(231) 780-1800
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes X No
----- -----
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, 2007, 1,468,800 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.............. 14
Item 3. Controls and Procedures........................... 26
PART II. Other Information
Item 1. Legal Proceedings................................. 26
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 ......................................... 27
Signatures................................................ 28
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30, December 31,
2007 2006
------------- ------------
(unaudited)
ASSETS
Cash and due from financial institutions $ 3,901,052 $ 3,398,155
Interest-bearing deposits in other financial institutions 66,121 72,115
Federal funds sold 0 5,600,000
------------ ------------
Total cash and cash equivalents 3,967,173 9,070,270
Securities
Available for sale (at fair value) 13,550,547 13,184,437
Held to maturity (fair value of $5,219,322 at September 30, 2007 and
$5,219,555 at December 31, 2006) 5,248,034 5,257,835
------------ ------------
Total securities 18,798,581 18,442,272
Loans held for sale 921,623 165,070
Loans 229,970,365 207,432,376
Less: Allowance for loan losses 3,111,096 2,549,016
------------ ------------
Net loans 226,859,269 204,883,360
Federal Home Loan Bank stock 404,100 404,100
Premises and equipment, net 12,641,544 10,958,821
Accrued interest receivable 1,369,554 1,249,680
Other assets 2,322,197 1,807,258
------------ ------------
Total assets $267,284,041 $246,980,831
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Non-interest bearing $ 18,175,949 $ 17,179,082
Interest bearing 207,040,122 197,103,330
------------ ------------
Total deposits 225,216,071 214,282,412
Federal funds purchased and repurchase agreements 13,506,499 4,494,614
Federal Home Loan Bank advances 6,000,000 6,000,000
Subordinated debentures 4,500,000 4,500,000
Notes Payable 1,106,043 400,000
Accrued expenses and other liabilities 592,300 1,185,180
------------ ------------
Total liabilities 250,920,913 230,862,206
Shareholders' equity
Preferred Stock, no par value: 1,000,000 shares
authorized and none issued 0 0
Common Stock, no par value: 9,000,000 shares authorized;
1,468,800 and 1,466,800 shares issued at September 30,2007 and
December 31, 2006 13,296,462 13,274,098
Retained Earnings 3,171,175 3,027,774
Accumulated other comprehensive loss (104,509) (183,247)
------------ ------------
Total shareholders' equity 16,363,128 16,118,625
------------ ------------
Total liabilities and shareholders' equity $267,284,041 $246,980,831
============ ============
See accompanying notes to consolidated financial statements.
-1-
COMMUNITY SHORES BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2007 2006 2007 2006
------------- ------------- ------------- -------------
INTEREST AND DIVIDEND INCOME
Loans, including fees $4,518,411 $4,098,809 $12,844,252 $11,468,639
Securities 213,087 181,241 632,891 541,281
Federal funds sold, FHLB dividends and other income 2,898 7,095 121,238 126,834
---------- ---------- ----------- -----------
Total interest income 4,734,396 4,287,145 13,598,381 12,136,754
INTEREST EXPENSE
Deposits 2,306,697 1,833,631 6,628,072 5,050,865
Repurchase agreements and federal funds purchased 139,248 107,957 279,755 218,640
Federal Home Loan Bank advances and notes payable 189,736 181,588 546,643 515,328
---------- ---------- ----------- -----------
Total interest expense 2,635,681 2,123,176 7,454,470 5,784,833
NET INTEREST INCOME 2,098,715 2,163,969 6,143,911 6,351,921
Provision for loan losses 406,675 216,873 802,006 518,625
---------- ---------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,692,040 1,947,096 5,341,905 5,833,296
Noninterest income
Service charges on deposit accounts 253,075 239,155 700,132 733,444
Mortgage loan referral fees 9,995 0 9,995 1,437
Gain on sale of loans 34,427 124,610 239,007 141,013
Gain on sale of securities 0 0 1,986 0
Gain (loss) on disposal of equipment 378 0 458 (124)
Other 119,547 97,015 345,120 261,250
---------- ---------- ----------- -----------
Total noninterest income 417,422 460,780 1,296,698 1,137,020
Noninterest expense
Salaries and employee benefits 1,288,097 992,048 3,709,793 2,930,124
Occupancy 146,642 100,828 430,217 275,902
Furniture and equipment 170,928 113,069 480,927 311,323
Advertising 38,037 90,778 128,865 174,570
Data processing 109,820 93,185 327,216 289,463
Professional services 131,020 166,603 403,602 424,394
Other 399,612 329,173 1,059,198 1,026,462
---------- ---------- ----------- -----------
Total noninterest expense 2,284,156 1,885,684 6,539,818 5,432,238
INCOME (LOSS) BEFORE INCOME TAXES (174,694) 522,192 98,785 1,538,078
Federal income tax expense (benefit) (71,690) 159,045 (44,616) 469,347
---------- ---------- ----------- -----------
NET INCOME (LOSS) $ (103,004) $ 363,147 $ 143,401 $ 1,068,731
========== ========== =========== ===========
Comprehensive income $ 72,812 $ 496,307 $ 222,139 $ 1,092,518
========== ========== =========== ===========
Weighted average shares outstanding 1,468,800 1,449,191 1,468,771 1,440,976
========== ========== =========== ===========
Diluted average shares outstanding 1,468,800 1,476,893 1,485,129 1,471,044
========== ========== =========== ===========
Basic EPS $ (0.07) $ 0.25 $ 0.10 $ 0.74
========== ========== =========== ===========
Diluted EPS $ (0.07) $ 0.25 $ 0.10 $ 0.73
========== ========== =========== ===========
See accompanying notes to consolidated financial statements.
-2-
COMMUNITY SHORES BANK CORPORATION
STATEMENT OF CHANGES OF SHAREHOLDERS' EQUITY
(UNAUDITED)
Accumulated
Other Total
Common Retained Comprehensive Shareholders'
Shares Stock Earnings Income (Loss) Equity
--------- ----------- ---------- ------------- -------------
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 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
========= =========== ========== ========= ===========
BALANCE AT JANUARY 1, 2007 1,466,800 $13,274,098 $3,027,774 $(183,247) $16,118,625
Proceeds from the exercise of stock options 2,000 20,460 20,460
Tax benefit from option exercise 1,904 1,904
Comprehensive income:
Net income 143,401 143,401
Unrealized gain on securities
available-for-sale 78,738 78,738
Total comprehensive income 222,139
--------- ----------- ---------- --------- -----------
BALANCE AT SEPTEMBER 30, 2007 1,468,800 $13,296,462 $3,171,175 $(104,509) $16,363,128
========= =========== ========== ========= ===========
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, September 30,
2007 2006
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 143,401 $ 1,068,731
Adjustments to reconcile net income to net cash
from operating activities
Provision for loan losses 802,006 518,625
Depreciation and amortization 457,703 217,331
Net amortization of securities 3,935 21,357
Net realized gain on sale of securities (1,986) 0
Net realized gain on sale of loans (239,007) (141,013)
Net realized (gain) loss on disposal of equipment (458) 124
Loans originated for sale (16,439,600) (2,766,245)
Proceeds from loan sales 15,922,054 2,907,257
Stock option compensation expense 0 1,328
Net change in:
Accrued interest receivable and other assets (254,375) (1,824,265)
Accrued interest payable and other liabilities (592,880) 476,424
------------ ------------
Net cash from (used in) operating activities (199,207) 479,654
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in available-for-sale securities:
Sales 494,650 0
Maturities, prepayments and calls 2,670,596 2,159,546
Purchases (3,404,204) (1,247,388)
Activity in held-to-maturity securities:
Maturities 0 185,000
Purchases 0 (537,262)
Loan originations and payments, net (23,198,915) (13,092,412)
Redemption of Federal Home Loan Bank stock 0 13,500
Additions to premises and equipment (2,139,968) (2,725,768)
------------ ------------
Net cash used in investing activities (25,577,841) (15,132,784)
CASH FLOW FROM FINANCING ACTIVITIES
Net change in deposits 10,933,659 15,004,891
Net change in federal funds purchased and
repurchase agreements 9,011,885 (1,038,358)
Other borrowing activity:
Draws on note payable and line of credit 1,512,086 600,000
Paydown on note payable (806,043) (200,000)
Tax benefit from exercise of stock options 1,904 0
Net proceeds from exercise of stock options 20,460 274,100
------------ ------------
Net cash from financing activities 20,673,951 14,640,633
Net change in cash and cash equivalents (5,103,097) (12,497)
Beginning cash and cash equivalents 9,070,270 4,651,459
------------ ------------
ENDING CASH AND CASH EQUIVALENTS $ 3,967,173 $ 4,638,962
============ ============
Supplemental cash flow information:
Cash paid during the period for interest $ 7,286,924 $ 5,599,930
Cash paid during the period for federal income tax 250,000 340,000
Transfers from loans to foreclosed assets 421,000 112,000
See accompanying notes to consolidated financial statements.
-4-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION AND RECENT ACCOUNTING DEVELOPMENTS:
The unaudited, consolidated financial statements as of and for the three
months and nine months ended September 30, 2007 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, 2007 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,
2006. Some items in the prior year financial statements were reclassified
to conform to the current presentation.
The Financial Accounting Standards Board ("FASB") Interpretation 48,
Accounting for Uncertainty in Income Taxes ("FIN 48"), was adopted as of
January 1, 2007. A tax position is recognized as a benefit only if it is
"more likely than not" that the tax position would be sustained in a tax
examination, with a tax examination being presumed to occur. The amount
recognized is the largest amount of tax benefit that is greater than 50%
likely of being realized on examination. For tax positions not meeting the
"more likely than not" test, no tax benefit is recorded. The adoption had
no affect on the Company's consolidated financial statements. The Company
is only subject to examinations of federal taxing authorities for years
after 2004. The Company and its subsidiaries are subject to U.S. federal
income tax. The Company is no longer subject to examination by taxing
authorities for years before 2004. The Company does not expect the total
amount of unrecognized tax benefits to significantly increase in the next
twelve months. The Company recognizes interest and/or penalties related to
income tax matters in income tax expense. The Company did not have any
amounts accrued for interest and penalties at September 30, 2007.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets" ("SFAS 156"). SFAS 156 addresses the accounting for
recognized servicing assets and servicing liabilities related to certain
transfers of the servicer's financial assets and for acquisitions or
assumptions of obligations to service financial assets that do not relate
to the financial assets of the servicer and its related parties. SFAS 156
requires that all recognized servicing assets and servicing liabilities are
initially measured at fair value, and subsequently measured at either fair
value or by applying an amortization method for each class of recognized
servicing assets and servicing liabilities. SFAS 156 was adopted as of
January 1, 2007 and the Company has chosen
-5-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION AND RECENT ACCOUNTING DEVELOPMENTS (Continued):
the fair value method of measurement. The adoption of SFAS 156 had no
material effect on the Company's consolidated financial statements.
In September 2006, the FASB issued Statement No. 157, Fair Value
Measurements. This statement defines fair value, establishes a framework
for measuring fair value and expands disclosures about fair value
measurements. This Statement established a fair value hierarchy about the
assumptions used to measure fair value and clarifies assumptions about risk
and the effect of a restriction on the sale or use of an asset. The
Standard is effective for fiscal years beginning after November 15, 2007.
The Company has not yet completed its evaluation of the impact of the
adoption of this standard.
In February 2006, FASB issued Statement No. 159, "The Fair Value Option for
Financial Assets and Liabilities" ("SFAS 159"). Adoption of SFAS 159 is
required for January 1, 2008. Early adoption was allowed, effective to
January 1, 2007, if that election was made by April 30, 2007. This
statement allows, but does not require, companies to record certain assets
and liabilities at their fair value. The fair value determination is made
at the instrument level, so similar assets or liabilities could be
partially accounted for using the historical cost method, while other
similar assets or liabilities are accounted for using the fair value
method. Changes in fair value are recorded through the income statement in
subsequent periods. The statement provides for a one time opportunity to
transfer existing assets and liabilities to fair value at the point of
adoption with a cumulative effect adjustment recorded against equity. After
adoption, the election to report assets or liabilities at fair value must
be made at the point of their inception. The Company did not elect early
adoption of SFAS 159 and has not yet determined which, if any, assets or
liabilities may be reported using the fair value accounting method. As
such, the Company has not yet determined the impact that the adoption of
this statement may have on the Company's consolidated financial statements.
2. SECURITIES
The following tables represent the securities held in the Company's
portfolio at September 30, 2007 and at December 31, 2006:
Gross Gross
Amortized Unrealized Unrealized Fair
September 30, 2007 Cost Gains Losses Value
- ------------------ ---------- ---------- --------- -----------
Available for sale:
US Government and federal agency $35,054 $ (46,131) $ 4,467,087
Municipal securities 3,873 0 343,770
Mortgage-backed securities 7,420 (158,563) 8,739,690
------- --------- -----------
$46,347 $(204,694) $13,550,547
Held to maturity:
Municipal securities $5,248,034 $ 5,292 $ (34,004) $ 5,219,322
-6-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2. SECURITIES (Continued)
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2006 Cost Gains Losses Value
- ----------------- ---------- ---------- ---------- -----------
Available for sale:
US Government and federal agency $ 6,015 $(108,742) $ 4,408,178
Municipal securities 4,500 (2,778) 707,516
Mortgage-backed securities 5,452 (182,094) 8,068,743
------- --------- -----------
15,967 (293,614) 13,184,437
Held to maturity:
Municipal securities $5,257,835 $ 2,552 $ (40,832) $ 5,219,555
Below is the schedule of maturities for securities held at September 30,
2007:
Held to Maturity
Available for Sale -----------------------
Fair Amortized Fair
Value Cost Value
------------------ ---------- ----------
Due in one year or less $ 0 $ 0 $ 0
Due from one to five years 3,216,808 1,164,562 1,163,753
Due in more than five years 1,594,049 4,083,472 4,055,569
Mortgage-backed 8,739,690 0 0
----------- ---------- ----------
$13,550,547 $5,248,034 $5,219,322
=========== ========== ==========
3. LOANS
The components of the outstanding loan balances:
September 30, 2007 December 31, 2006
------------------ -----------------
Commercial $ 88,962,792 $ 90,422,689
Real Estate:
Commercial 92,307,219 78,012,565
Residential 14,353,427 10,172,321
Construction 4,791,376 1,334,276
Consumer 29,693,288 27,616,155
------------ ------------
Subtotal: 230,108,102 207,558,006
Allowance for loan losses (3,111,096) (2,549,016)
Net deferred loan fees (137,737) (125,630)
------------ ------------
Loans, Net $226,859,269 $204,883,360
============ ============
Loans held for sale totaled $921,623 at September 30, 2007 and $165,070 at
December 31, 2006.
-7-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. 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, 2007 and
2006:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
9/30/07 09/30/06 9/30/07 09/30/06
------------ ------------ ----------- -----------
Beginning Balance 2,796,103 $2,436,765 2,549,016 $2,612,581
Charge-offs
Commercial (48,856) (80,130) (75,506) (460,737)
Real Estate-Commercial 0 0 (25,463) 0
Real Estate-Residential 0 0 0 0
Real Estate-Construction 0 0 0 0
Consumer (52,068) (31,834) (169,637) (176,214)
---------- ---------- ---------- ----------
Total Charge-offs (100,924) (111,964) (270,606) (636,951)
---------- ---------- ---------- ----------
Recoveries
Commercial 2,301 1,607 6,925 9,527
Real Estate-Commercial 0 0 0 0
Real Estate-Residential 0 0 0 0
Real Estate-Construction 0 0 0 0
Consumer 6,941 3,546 23,755 43,045
---------- ---------- ---------- ----------
Total Recoveries 9,242 5,153 30,680 52,572
---------- ---------- ---------- ----------
Net Charge-Offs (91,682) (106,811) (239,926) (584,379)
---------- ---------- ---------- ----------
Provision for loan losses 406,675 216,873 802,006 518,625
---------- ---------- ---------- ----------
Ending Balance $3,111,096 $2,546,827 $3,111,096 $2,546,827
========== ========== ========== ==========
Impaired loans were as follows:
09/30/07 12/31/06
---------- ----------
Period-end loans with no specific allocated allowance for loan losses: -- $ 244,329
Period-end loans with specific allowance for loan losses: $3,068,558 1,209,023
---------- ----------
Total: $3,068,558 $1,453,352
========== ==========
Amount of the allowance for loan losses specifically allocated: $ 468,749 $ 230,856
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
9/30/07 9/30/06 09/30/07 9/30/06
------------ ------------ ----------- -----------
Average of impaired loans during the period: $2,513,882 $851,818 $2,244,128 $1,231,918
Interest income recognized during impairment: 3,782 773 36,317 15,224
Cash-basis interest income recognized: 3,305 207 8,649 10,355
-8-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):
Non-performing loans were as follows:
09/30/07 12/31/06
---------- --------
Loans past due over 90 days still on accrual: $ 632,005 $729,965
Non-accrual loans: $2,466,527 $400,597
Non-performing loans and impaired loans are defined differently. Some loans
may be included in both categories, whereas other loans may only be
included in one category.
5. PREMISES AND EQUIPMENT
Period end premises and equipment were as follows:
September 30, December 31,
2007 2006
------------- ------------
Land & land improvements $ 5,455,864 $ 4,913,807
Buildings & building improvements 5,845,580 4,069,215
Furniture, fixtures and equipment 3,641,227 2,922,359
Construction in Process 20,263 1,082,722
----------- -----------
14,962,934 12,988,103
Less: accumulated depreciation 2,321,390 2,029,282
----------- -----------
$12,641,544 $10,958,821
=========== ===========
6. DEPOSITS
The components of the outstanding deposit balances at September 30, 2007
and December 31, 2006 were as follows:
September 30, December 31,
2007 Balance 2006 Balance
------------- ------------
Non-interest bearing
Demand $ 18,175,949 $ 17,179,082
Interest bearing
Checking 18,740,941 18,606,890
Money Market 21,587,489 17,648,173
Savings 15,426,070 13,113,050
Time, under $100,000 44,666,647 39,154,246
Time, over $100,000 106,618,975 108,580,971
------------ ------------
Total Deposits $225,216,071 $214,282,412
============ ============
-9-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. SHORT-TERM BORROWINGS
The Company's short-term borrowings typically consist of repurchase
agreements and federal funds purchased. The September 30, 2007 and December
31, 2006 information was as follows:
Repurchase Federal Funds
Agreements Purchased
---------- -------------
Outstanding at September 30, 2007 $5,406,499 $8,100,000
Average interest rate at period end 3.11% 4.95%
Average balance during year 5,083,225 3,718,637
Average interest rate during year 3.35% 5.42%
Maximum month end balance during year 5,695,329 8,500,000
Outstanding at December 31, 2006 $4,494,614 $ 0
Average interest rate at year end 3.34% 0.00%
Average balance during year 4,993,710 2,078,479
Average interest rate during year 3.17% 5.46%
Maximum month end balance during year 5,758,378 6,700,000
8. 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 $6,900,000.
Each borrowing requires a direct pledge of securities or loans. At
September 30, 2007, the Bank had assets with a market value of $9,258,973
pledged to the Federal Home Loan Bank to support current borrowings.
Details of the Bank's outstanding borrowings at both September 30, 2007 and
December 31, 2006 are:
Current September 30, December 31,
Maturity Date Interest Rate 2007 2006
------------- ------------- ------------- ------------
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
9. 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 7.28063%
at September 30, 2007. 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
-10-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
9. SUBORDINATED DEBENTURES (Continued)
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 October 1, 2007 because September
30, 2007 fell on a weekend. 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.
10. NOTES PAYABLE
On September 7, 2007, the Company refinanced its $5 million line of credit
with Fifth Third Bank ("Fifth Third"); the line was formerly with LaSalle
Bank National Association ("LaSalle"). The LaSalle line of credit matured
during the quarter and had an outstanding balance of $806,043. On December
31, 2006 the balance on the LaSalle line was $400,000. On September 7,
2007, the Company executed its first draw on its line of credit with Fifth
Third in the amount of $806,043. The draw was used solely for the purpose
of paying off the principal and interest owed to LaSalle upon maturity of
the Company's former line of credit. Through September 30, there has been
one additional draw for $300,000 which occurred on September 28. The
proceeds were essentially used for the general operating expenses of the
Company and to contribute capital to the Bank. On September 30, 2007 the
outstanding balance and rate on the Fifth Third line was $1,106,043 and
6.75% respectively. The Fifth Third line is floating and bears interest on
outstanding principal at a rate of 100 basis points below Fifth Third's
internal prime rate, which is currently 7.50%. Interest is owed quarterly
in arrears on the first business day of February, May, August, and November
and the borrowings may be prepaid in whole or in part without any
prepayment penalty.
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
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.
-11-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
11. COMMITMENTS AND OFF-BALANCE SHEET RISK (Continued)
A summary of the notional and contractual amounts of outstanding financing
instruments with off-balance-sheet risk as of September 30, 2007 and
December 31, 2006 follows:
September 30, December 31,
2007 2006
------------- ------------
Unused lines of credit and letters of credit $40,650,165 $39,135,932
Commitments to make loans 817,980 816,646
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. INCOME TAXES
Federal tax expense was lower in the first nine months of 2007 compared to
the first nine months of 2006. The decrease is not only related to lower
pre-tax income but also to an adjustment that occurred in the first quarter
of 2007 when the Company reevaluated its federal tax accruals and concluded
that tax liabilities needed to be modified reducing federal tax expense
recorded in that quarter by $36,000. The federal tax benefit that was
recorded in both the second and third quarters of 2007 was due to the
proportion of tax free municipal bond income to consolidated pre-tax
income.
13. REGULATORY MATTERS
Banks 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. Failure to meet various capital
requirements can initiate regulatory action.
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, regulatory 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 Bank was designated as well-capitalized under the regulatory framework
for prompt corrective action at both September 30, 2007 and December 31,
2006.
-12-
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
13. REGULATORY MATTERS (Continued)
Actual and required capital amounts and ratios at September 30, 2007 and
December 31, 2006 for the 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, 2007
Total Capital (Tier 1 and Tier
2) to risk weighted assets
of the Bank $25,163,180 10.07% $19,985,448 8.00% $24,981,810 10.00%
Tier 1 (Core) Capital to risk
to risk-weighted
assets of the Bank 22,052,084 8.83 9,992,724 4.00 14,989,086 6.00
Tier 1 (Core) Capital to
to average assets
of the Bank 22,052,084 8.35 10,562,320 4.00 13,202,900 5.00
December 31, 2006
Total Capital (Tier 1 and Tier
2) to risk weighted assets
of the Bank $23,532,791 10.45% $18,020,232 8.00% $22,525,290 10.00%
Tier 1 (Core) Capital to risk
to risk-weighted
assets of the Bank 20,983,775 9.32 9,010,116 4.00 13,515,174 6.00
Tier 1 (Core) Capital to
to average assets
of the Bank 20,983,775 8.73 9,618,321 4.00 12,022,901 5.00
-13-
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, 2007 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, 2007 to that at December 31, 2006. The part labeled
Results of Operations discusses the three month and nine month periods ended
September 30, 2007 as compared to the same periods of 2006. Both parts should be
read in conjunction with the interim consolidated financial statements and
footnotes included in Item 1 of Part I 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 $20.3 million to $267.3 million at September 30, 2007
from $247.0 million at December 31, 2006. This is a 8.2% increase in assets
during the first nine months of 2007. Asset growth was funded by deposit and
borrowings growth and consisted primarily of increases in the loan portfolio and
premises and equipment.
-14-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Cash and cash equivalents decreased by $5.1 million to $4.0 million at September
30, 2007 from $9.1 million at December 31, 2006. This decrease was the net
effect of increased balances held at other financial institutions being offset
by a decrease in federal funds sold. Changes in these balances are related to
fluctuations in the liquidity of the Bank and its customers on those particular
days.
Total loans climbed to $230.0 million at September 30, 2007 from $207.4 million
at December 31, 2006. The $22.6 million net increase is comprised of $12.8
million growth in the commercial and commercial real estate portfolios, $7.7
million growth in residential mortgage and construction loans and $2.1 million
in consumer loans. The Bank still maintains a focus on commercial lending.
However one of the Bank's recent initiatives was to increase its mortgage
lending presence in the local marketplace. To execute this strategy, the Bank
recruited five well-known, experienced mortgage originators. As in the past, it
is the Bank's intention to sell in the secondary market a majority of the
residential real estate loans originated, however there will be situations that
will require the Bank to retain a loan for its own portfolio. The 41% increase
in residential real estate loans since year-end 2006 is not necessarily
indicative of future growth in this portfolio. A portion of the residential loan
increase was related to an event that occurred late in the second quarter. One
of the Bank's main purchasers of its residential loans decided to quickly exit
the loan business forcing the Bank to retain several loans that were in the
pipeline and slated for sale. Even with the current focus on the mortgage
initiative, the Bank intends on maintaining its commercial focus which is
evidenced by the fact that the commercial and commercial real estate categories
of loans still comprise 79% of the Bank's total loan portfolio.
Other lending activity during the first nine months of 2007 included the
origination of $16.4 million in loans that were sold in the secondary market,
89% were mortgage loans. Mortgage loans are sold servicing released. The
correlated gain on the mortgage activity was $103,000. Other origination
activity was related to Small Business Association ("SBA") loans. Since January
there have been $1.9 million originated and $1.8 million sold. The associated
gains from 2007's sales were $136,000.The Bank's SBA lending program was
developed in the second half of 2006 and consists mainly of selling the
guaranteed portion of floating rate SBA loans that the Bank originates. The Bank
retains the unguaranteed portion which is generally 20% to 25% of the
outstanding principal. The originations from these business lines totaled $2.9
million for the first nine months of 2006 with 78% being SBA loans. The total
gains recorded for both the sales of SBA and mortgage loans in the first nine
months of 2006 were $141,000.
-15-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
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, 2007 are included below:
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
----------- ----------- ------------ ----------- ------------
Commercial, financial and other $18,944,466 $34,826,653 $ 33,355,828 $ 2,124,643 $ 89,251,590
Real estate:
commercial 14,665,054 19,916,621 55,024,587 2,617,710 92,223,972
construction 288,727 3,555,673 399 946,576 4,791,375
mortgages 97,530 322,137 2,005,355 11,870,982 14,296,004
Consumer 1,991,165 4,020,874 19,847,548 3,547,837 29,407,424
----------- ----------- ------------ ----------- ------------
$35,986,942 $62,641,958 $110,233,717 $21,107,748 $229,970,365
=========== =========== ============ =========== ============
Loans at fixed rates 8,036,194 13,415,686 94,476,229 18,052,760 133,980,869
Loans at variable rates 27,950,748 49,226,272 15,757,488 3,054,988 95,989,496
----------- ----------- ------------ ----------- ------------
$35,986,942 $62,641,958 $110,233,717 $21,107,748 $229,970,365
=========== =========== ============ =========== ============
At September 30, 2007, 58% of the loan balances carried a fixed rate and 42% a
floating rate. As the mortgage loan activity increases there could be a change
in the contractual maturity composition of the Bank's loan portfolio. Generally
mortgage loans have a contractual maturity of up to thirty years. Although the
contractual maturities may be as long as thirty years, it is common practice for
mortgage loans to have an average life that is closer to seven to ten years.
Management is watching the entire loan portfolio carefully and is endeavoring to
avoid exposing the Bank to excessive extension risk. Since June 30, 2007, the
Bank's contractual maturities longer than five years have remained at 9% of the
entire portfolio.
The recent economic climate in Michigan has been very weak particularly in the
real estate sector. The most vulnerable credits appear to be loans secured by
real estate for the purposes of land development. Although the Bank has a
significant level of commercial real estate loans, a large portion of the real
estate collateral is owner-occupied. Less than 5% of the Bank's entire loan
portfolio is in land development loans.
Credit risk is another type of risk inherent in banking. Management is actively
involved in credit risk oversight. Monthly the loan portfolio is reviewed and
analyzed 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, 2007, the allowance totaled $3.1 million. 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.
-16-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
The allocation of the allowance at September 30, 2007 was as follows:
September 30, 2007 December 31, 2006
-------------------------- --------------------------
Percent of Percent of
Allowance Allowance
Related to Related to
Amount Loan Category Amount Loan Category
---------- ------------- ---------- -------------
Balance at End of Period Applicable to:
Commercial $1,464,147 47.1% $1,239,909 48.7%
Real estate:
Commercial 1,224,499 39.4 943,907 37.0
Residential 71,480 2.3 50,862 2.0
Construction 55,101 1.7 15,344 0.6
Consumer 295,869 9.5 298,994 11.7
---------- ----- ---------- -----
Total $3,111,096 100.0% $2,549,016 100.0%
========== ===== ========== =====
The ratio of allowance for loan losses to total loans increased to 1.35% from a
level of 1.23% at December 31, 2006. The increase is related to the $2.1 million
increase in non-accrual loans since year-end 2006 as well as the declining real
estate market in Michigan. Management continues to monitor the allocations on a
monthly basis and makes adjustments to the provision and the allowance based on
portfolio concentration levels, actual loss experience and the financial
condition of the borrowers. An additional $802,000 was added to the allowance
through provision for loan losses during the first nine months of 2007 with
$407,000 being added in the third quarter. During the third quarter there was a
specific allocation of over $100,000 for a commercial customer that unexpectedly
filed bankruptcy.
Another significant 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, 2007 compared
to those at year-end 2006 and the corresponding change, related to those two
periods.
Increase
Loans Past Due: September 30, 2007 December 31, 2006 (Decrease)
- --------------- ------------------ ----------------- ----------
30-59 days $1,042,462 $1,407,140 $ (364,678)
60-89 days 1,232,884 885,689 347,195
90 days and greater 632,005 729,965 (97,960)
Non accrual loans $2,466,527 $ 400,597 $2,065,930
Since year-end 2006, overall past due and non accrual balances balances have
decreased by $1.9 million. Non accruals have increased by $2.1 million and were
slightly offset by a $115,000 decrease in loans past due. A portion of the non
accrual activity is related to loans moving out of various past due categories
and being reclassed into the non-accrual category. Five commercial
relationships comprise almost the entire balance. The primary collateral
supporting the borrowings in four of the five cases is real estate and as a
result of the declining real estate market in the state of Michigan, there have
been increased specific allocations relative to impaired loans particularly
those that have real estate based collateral. The current allowance allocations
for these impaired loans are considered adequate based on expected loss on
-17-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
disposition of collateral. The increase in specific allocations has had a
considerable increase on the provision expense recorded in the first nine months
of 2007.
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 0.15%
for the first nine months of 2007, down from 0.40% for the first nine months of
2006. There were net charge-offs of $240,000 recorded for the first nine months
of 2007, which is much lower than net charge-offs of $584,000 for the similar
period in 2006. Approximately 40% of the balances charged off in the first nine
months of 2006 had specific allocations in the allowance for loan losses and
many were on non accrual status. More than half (56%) of the recorded
charge-offs in the first nine months of 2006 were related to one impaired
commercial relationship which was identified in the fourth quarter of 2005.
Bank premises and equipment increased $1.7 million during the first nine months
of 2007. A small portion of the increase was the remaining costs associated with
the completion of the North Muskegon branch building which became operational on
January 5, 2007. The other significant expenditure was for the construction of a
building for the Bank's Grand Haven banking location. The Grand Haven branch
relocated from its leased space in August 2007 to its new building near the
corner of US-31 and Taylor Street. The Company has completed all of its
construction projects as of September 2007. The Bank owns one vacant land parcel
at the corner of Apple Avenue and Quarterline in the City of Muskegon. There are
no immediate plans to build on the Apple Avenue land.
Other assets rose $515,000 since December 31, 2006. The largest item
contributing to the change is the addition of $421,000 in other real estate
owned between the two period ends. Other real estate owned is comprised of
properties relinquished by customers through the collection process. As
properties are added to other real estate owned they are written down to market
value (less estimated selling costs) based on a professional appraisal or other
common means of valuation. Currently there are 6 properties being held. There
have been three properties added and one disposition since December 31, 2006.
The largest addition during the first nine months of 2007 was a residence in the
Grand Haven area. If any property in this category is sold for less than it is
being held, further losses could result.
Deposit balances were $225.2 million at September 30, 2007 up from $214.3
million at December 31, 2006. Total deposit growth since year-end was $10.9
million or 5.1%. Increases were recorded in all types of accounts except time
deposits greater than $100,000. The growth in deposits has allowed the Bank to
surpass one of its super regional, local competitors to attain third position in
deposit market share in the Bank's defined market area(1).
Deposit growth is due to several of the Bank's large public fund customers
increasing their holdings since year-end as well as contributions from the
enhanced branch system. Since year-end 2006, non-interest bearing checking
accounts increased nearly $1 million or 5.8% while interest bearing checking
accounts and savings accounts grew $6.4 million. Local time deposits grew $5.5
million in the first nine months of 2007. Resulting from the growth of local
- ----------
(1) The defined market area referred to in this statistic consists of the
northern Ottawa communities of Ferrysburg, Spring Lake and Grand Haven and
all Muskegon County communities except Montague.
-18-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
deposits the Bank was able to reduce its concentration 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. Since
December 31, 2006, the Bank decreased its total balance of brokered deposits by
$2.0 million and the ratio of brokered deposits to total deposits decreased from
37% at December 31, 2006 to a level of 34% at September 30, 2007. The Bank
intends on decreasing its dependency on brokered funds as its branching network
in the local market strengthens.
The notes payable balance consists of draws on the Company's $5 million
revolving line of credit which is now with Fifth Third. The balance has
increased $706,043 since December 31, 2006 as a result of draws made in June and
September. The proceeds were used for the general operating expenses of the
Company and to contribute capital to the Bank to ensure that it maintained a
well-capitalized regulatory status. Future draws are expected for similar
reasons.
Shareholders' equity totaled $16.4 million and $16.1 million at September 30,
2007 and December 31, 2006 respectively. The increase consists of earnings
recorded in the first nine months of the year, a decrease in accumulated other
comprehensive loss (security market value adjustments) and one stock option
exercise.
RESULTS OF OPERATIONS
The net income for the first nine months of 2007 was $143,000 which was $925,000
less than the similar period in 2006. The corresponding basic and diluted
earnings per share for the first nine months of 2007 was $0.10 compared to $0.74
and $0.73 respectively for 2006. Year to date 2007 earnings were impacted by a
lower net interest margin coupled with higher loan loss provision and higher
personnel and depreciation costs associated with two new branch buildings--one
in a new market and one replacement building and the undertaking of a mortgage
initiative.
The Company recorded a $103,000 net loss for the third quarter of 2007 while the
same period in 2006 netted earnings of $363,000. The corresponding basic and
diluted earnings per share for the third quarter of 2007 were -$0.07 compared to
$0.25 for the similar period in 2006. These results are indicative of the higher
loan loss provision as well as the significant investments the Company has made
in branch facilities over the past nine months and the second quarter
recruitment of five mortgage originators and support staff. Rising loan loss
provision expense is directly related to the weak Michigan economy and its
effect on real estate values and businesses throughout the state. The branching
strategy is working as evidenced by an increase in deposit market share however
there is still progress to be made in the way of gathering lower costing funds
and improving the Bank's net interest margin. The mortgage strategy has had
inconsistent returns, and in addition to being beset with start up costs, there
have been the added challenges of the current real estate market and the
declining pool of secondary market investors.
For the first nine months and third quarter of 2007, the annualized return on
the Company's average total assets was 0.07% and -0.15%, respectively, which is
down from 0.62% annualized return for both of the same periods in 2006. The
Company's annualized return on
-19-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
average equity was 1.17% and -2.51% for the first nine months and third quarter
of 2007 and 9.42% and 9.33% for the first nine months and third quarter of 2006.
The ratio of average equity to average assets was 6.41% and 6.21% for the first
nine months and third quarter of 2007 and 6.60% and 6.67% for the same periods
in 2006.
As mentioned above, significant differences between the operating results of the
first nine months of 2006 and 2007 are 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.
Nine months ended September 30,
---------------------------------------------------------------------------
2007 2006
------------------------------------ ------------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------------ ----------- ------- ------------ ----------- -------
Assets
Federal funds sold and interest-
bearing deposits with other
financial institutions $ 3,101,880 $ 121,238 5.21% $ 3,720,311 $ 126,834 4.55%
Securities 19,421,139 718,767 4.93 19,430,919 621,798 4.27
Loans (including held for sale
and non accrual) 216,205,928 12,844,252 7.92 196,017,819 11,468,639 7.80
------------ ----------- ------ ------------ ----------- ------
238,728,947 13,684,257 7.64 219,169,049 12,217,271 7.43
Other assets 16,441,876 10,198,478
------------ ------------
$255,170,823 $229,367,527
============ ============
Liabilities and Shareholders' Equity
Interest-bearing deposits $199,874,672 $ 6,628,072 4.42 $177,886,277 $ 5,050,865 3.79
Federal funds purchased, repur--
chase agreements and Federal
Reserve Bank borrowings 8,820,177 279,755 4.23 7,488,944 218,640 3.89
Subordinated Debentures, Note
Payable and Federal Home Loan
Bank Advances 11,041,557 546,643 6.60 10,704,396 515,328 6.42
------------ ----------- ------ ------------ ----------- ------
219,736,406 7,454,470 4.52 196,079,617 5,784,833 3.93
----------- -----------
Non-interest bearing deposits 18,193,034 17,564,795
Other liabilities 875,926 589,265
Shareholders' Equity 16,365,457 15,133,850
------------ ------------
$255,170,823 $229,367,527
============ ============
Net interest income
(tax equivalent basis) 6,229,787 6,432,438
Net interest spread on earning assets
(tax equivalent basis) 3.12% 3.50%
====== ======
Net interest margin on earning assets
(tax equivalent basis) 3.48% 3.91%
====== ======
Average interest-earning assets to
average interest-bearing liabilities 108.64% 111.78%
====== ======
Tax equivalent adjustment 85,876 80,517
----------- -----------
Net interest income $ 6,143,911 $ 6,351,921
=========== ===========
-20-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
The tax equivalent net interest spread on average earning assets decreased 38
basis points to 3.12% since September 30, 2006. The tax equivalent net interest
margin decreased by 43 basis points from 3.91% at September 30, 2006 to 3.48% at
September 30, 2007. The tax equivalent net interest income for the first nine
months of 2007 was $6.2 million compared to a figure of $6.4 million for the
same nine months in 2006. The Company recorded $208,000 less net interest income
although there were $19.6 million more average earning assets on the books. The
net interest margin compression between the two periods was mostly a result of
increased cost of funds between the first nine months of 2006 compared to the
similar period in 2007. Relative increases to loan income from higher internal
prime lending rates and more average loans outstanding were not enough to offset
the 59 basis point increase in expense experienced on the deposit side from a
rate and outstanding balance perspective.
The average rate earned on interest earning assets was 7.64% for the nine months
ended September 30, 2007 compared to 7.43% for the same period in 2006. The main
contributing factor was a 12 basis point increase in the yield on loans, the
Bank's largest earning asset category. The Bank's internal prime rate was 37
basis points higher between the first nine months of 2007 and that of 2006.
Internal prime rate changes, no matter what direction, affect interest earned on
variable rate loans and new loan volume. Typically the Bank's loan portfolio is
fairly balanced between fixed and floating rate loans however over the last year
customers have preferred fixed rate terms causing the concentration of floating
rate loans to be reduced to 42% as of September 30, 2007. As of September 30,
2006 the concentration was 48%. This reduction of floating rate loans is helpful
to net interest income in a downward rate environment such as the one we are
experiencing.
Interest expense incurred on deposits, repurchase agreements, federal funds
purchased, Federal Home Loan Bank advances and Notes Payable increased by 59
basis points for the first nine months of 2007 compared to the first nine months
of 2006. During 2006, 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 2007, deposit rates continued to rise while lending rates remained
stable. Now that lending rates are decreasing there may be opportunities to
reduce the Bank's cost of funds, particularly in its time deposit portfolio. In
the next ninety days there will be $38 million of time deposits repricing. The
average rate on these deposits is currently 5.15%. Based on the current treasury
yield curve and local competition, it is likely that these deposits will reprice
on average 40-60 basis points less. Although this is helpful in the short term
it is management's long term goal for the Bank's branching system to attract
lower costing funds adjusting the mix of the Bank's outstanding deposits towards
one that has less dependence on large time deposits, particularly those that are
brokered. Achieving this should positively affect the Company's net interest
margin.
-21-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
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, 2007 and 2006 is
in the table below.
Three months ended September 30,
--------------------------------------------------------------------------
2007 2006
------------------------------------ ------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------------ ---------- ---------- ------------ ---------- ----------
Assets
Federal funds sold and interest-bearing deposits
with other financial institutions $ 253,603 $ 2,898 4.57% $ 566,559 $ 7,095 5.01%
Securities 19,269,696 241,190 5.01 19,201,745 208,480 4.34
Loans (including held for sale and non accrual) 227,545,720 4,518,411 7.94 202,431,823 4,098,809 8.10
------------ ---------- ------ ------------ ---------- ------
247,069,019 4,762,499 7.71 222,200,127 4,314,384 7.77
Other assets 17,043,335 11,199,417
------------ ------------
$264,112,354 $233,399,544
============ ============
Liabilities and Shareholders' Equity
Interest-bearing deposits $204,710,229 $2,306,697 4.51 $178,115,917 $1,833,631 4.12
Federal funds purchased, repur-chase agreements
and Federal Reserve Bank borrowings 12,187,580 139,248 4.57 9,636,852 107,957 4.48
Subordinated Debentures, Note Payable and
Federal Home Loan Bank Advances 11,311,359 189,736 6.71 10,828,261 181,588 6.71
------------ ---------- ------ ------------ ---------- ------
228,209,168 2,635,681 4.62 198,581,030 2,123,176 4.28
---------- ----------
Non-interest bearing deposits 18,830,177 18,377,412
Other liabilities 662,480 872,117
Shareholders' Equity 16,410,529 15,568,985
------------ ------------
$264,112,354 $233,399,544
============ ============
Net interest income (tax equivalent basis) 2,126,818 2,191,208
Net interest spread on earning assets (tax
equivalent basis) 3.09% 3.49%
====== ======
Net interest margin on earning assets (tax
equivalent basis) 3.44% 3.94%
====== ======
Average interest-earning assets to average
interest-bearing liabilities 108.26% 111.89%
====== ======
Tax equivalent adjustment 28,103 27,239
---------- ----------
Net interest income $2,098,715 $2,163,969
========== ==========
Similar to the comparison of the net interest income results of the first nine
months of 2006 to that of the first nine months of 2007, there was a decrease in
tax equivalent net interest income between the two quarters and there was net
interest margin compression. Tax equivalent net interest income decreased by
$64,000 in spite of the fact that there was $24.9 million more average earning
assets between the third quarter of 2007 and the third quarter of 2006. The tax
equivalent net interest spread and margin declined by 40 and 50 basis points
respectively between the third quarter of 2006 and the similar period in 2007.
The results were the effect of both a decline in the yield earned on interest
earning assets between the two periods coupled with a 34 basis point increase in
the Company's cost of funds between the third quarter of 2006 and that of 2007.
-22-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
As the Bank's cost of funds increases and prime rate changes are always a
possibility, asset liability management has become 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 realizing 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, of 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 highly competitive and changing rate environment. Details of the
repricing gap at September 30, 2007 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 $ 66,121 $ 0 $ 0 $ 0 $ 66,121
Federal Funds Sold 0 0 0 0 0
Securities (including FHLB stock) 1,043,095 1,477,618 10,624,474 6,057,494 19,202,681
Loans Held for Sale 0 0 0 921,623 921,623
Loans(1) 104,858,167 18,971,712 91,370,291 14,770,195 229,970,365
------------ ------------ ------------ ----------- ------------
105,967,383 20,449,330 101,994,765 21,749,312 250,160,790
Interest-bearing liabilities
Savings and checking 55,754,500 0 0 0 55,754,500
Time deposits <$100,000 12,600,684 25,507,758 6,558,205 0 44,666,647
Time deposits >$100,000 25,350,956 46,289,383 34,978,636 0 106,618,975
Repurchase agreements and
Federal funds purchased 13,506,499 0 0 0 13,506,499
Subordinated Debt and Federal
Home Loan Bank Advances 11,606,043 0 0 0 11,606,043
------------ ------------ ------------ ----------- ------------
118,818,682 71,797,141 41,536,841 0 232,152,664
Net asset (liability) repricing gap $(12,851,299) $(51,347,811) $ 60,457,924 $21,749,312 $ 18,008,126
============ ============ ============ =========== ============
Cumulative net asset (liability)
Repricing gap $(12,851,299) $(64,199,110) $ (3,741,186) $18,008,126
============ ============ ============ ===========
- ----------
(1) Includes non accrual loans.
-23-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
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 decreases 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 down by 25 basis points and every interest earning asset and
interest bearing liability on the Company's September 30, 2007 balance sheet
repricing in the next twelve months adjusted simultaneously by the same 25 basis
points, more liabilities would be affected than assets. Theoretically the
current declining rate environment should have a positive affect on net interest
income and earnings. The unknown factor is the effect of local pricing from
competitors and the exact timing of deposit repricing lags.
The provision for loan losses for the third quarter and the first nine months of
2007 were $407,000 and $802,000 compared to figures of $217,000 and $519,000 for
the same periods in 2006. The increase in the provision expense is not only
related to new loan growth but it is also related to the increase in non
performing and troubled credits that have been identified. The ratio of
non-performing loans(1) as a percentage of total loans has nearly doubled in the
last twelve months. The increased provision expense has made the ratio of the
allowance for loan losses to total loans increase by 12 basis points to a level
of 1.35%. 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 2007 totaled $1.3
million and represented a 14% increase compared to last year's first nine months
total, which was $1.1 million. The main underlying factor was an increase in
gains on mortgage loan sales recorded. In the first nine months of 2007, the
gains on sales of these products totaled $113,000 compared to $22,000 recorded
in the first nine months of 2006. Gains on sales of SBA loans were $16,000 more
for the first nine months of 2007 compared to the same period in 2006. Increases
to gain on loan sales were offset by a $21,000 decline in fees earned on the
Bank's overdraft protection product mostly caused by lower commercial customer
usage than in the past.
Non-interest income for the third quarter of 2007 was $43,000 less than the
$461,000 recorded in the same quarter of 2006. A significant portion of the
decrease is derived from differences in gains on SBA loan sales. There were no
gains recorded in the third quarter of 2007 compared to $121,000 recorded in the
third quarter of 2006.
Non-interest expenses for the first nine months of 2007 were $6.5 million
compared to a total of $5.4 million for 2006, an increase of 20%. The third
quarter non-interest expense total was $2.3 million for 2007 and $1.9 million
for 2006. The notable variances among the individual categories were in the
areas of salaries and benefits and occupancy and equipment expenses.
On average there were an additional 19 full-time equivalent employees during the
first nine months of 2007 compared to the same period of 2006. These additions
as well as general staff compensation increases resulted in a 27% growth in
total salaries and benefits expense.
- ----------
(1) Non performing loans are defined as those that are past due 90 days or more
or are on non accrual.
-24-
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
Additions to staff were made for the newly created fourth branch facility as
well as to support the growth of the Bank from both a sales and operational
standpoint. The recently implemented mortgage initiative added nine full-time
equivalent employees in the second quarter of 2007. There were associated
recruiting costs for this effort. The $780,000 increase in salaries and benefits
between the first nine months of 2007 and the similar period in 2006 accounted
for 14% of the increase in total non interest expenses.
For the third quarter of 2007, salaries and benefits were $296,000 higher than
the similar period in 2006. For that period the difference in full-time
equivalent people was 20. The salaries and benefits expenses recorded for the
third quarter of 2007 included recruiting expenses associated with the mortgage
initiative. At this time, the Bank is planning to move the five mortgage
originators currently on staff to a more commissioned-based compensation
program.
Occupancy and equipment expenses were $911,000 and $318,000 for the first nine
months and third quarter of 2007 respectively compared to $587,000 and $214,000
for the first nine months and third quarter of 2006. The increases between the
four periods is directly related to depreciation expense from the construction
of a fourth banking location which became operational in the fourth quarter of
2006 as well as the construction of a replacement banking facility in North
Muskegon which opened in January of 2007. In August, the Grand Haven location
construction was completed and the branch was relocated to its new facility.
Going forward equipment expenses will rise as a result. It is not anticipated
that occupancy expenses will be affected as a result of the Grand Haven branch
because the building depreciation costs are offset by the cessation of rental
payments.
Other non interest expenses were $400,000 for the third quarter of 2007, an
increase of $70,000 compared to the $329,000 recorded in the same quarter of
2006. In the third quarter of 2007, the Bank incurred increased FDIC fees of
approximately $34,000 because of a surcharge that was instituted by the FDIC in
the third quarter to force newly chartered banks to pay into their reserve fund.
It is not known how long the surcharge will be in effect. Mortgage loan related
expenses increased as a result of more originations.
Federal tax expense was lower in the first nine months of 2007 compared to the
first nine months of 2006. The decrease is not only related to lower pre-tax
income but also to an adjustment that occurred in the first quarter of 2007 when
the Company reevaluated its federal tax accruals and concluded that tax
liabilities needed to be modified reducing federal tax expense recorded in that
quarter by $36,000. The federal tax benefit that was recorded in the third
quarter of 2007 was due to the proportion of tax free municipal bond income to
consolidated pre-tax income.
-25-
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, 2007. 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, 2007 with respect to information required to be
disclosed by the Company in reports that it files or submits under the Exchange
Act. No change in the Company's internal control over financial reporting (as
defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of
1934) occurred during the most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, its internal control
over financial reporting.
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
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
Not applicable.
-26-
COMMUNITY SHORES BANK CORPORATION
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 Form 8-K filed July 5, 2006 (SEC file
number 000-51166)
10.1 Loan Agreement between Community Shores Bank Corporation and
Fifth Third Bank dated September 7, 2007
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
32.2 Section 1350 Certification of Chief Financial Officer
-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, 2007.
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)
-28-
EXHIBIT INDEX
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- -----------------------------------------------------------------
3.1 Articles of Incorporation of the Company are incorporated by
reference to exhibit 3.1 of the Company's June 30, 2004 Form
10-QSB (SEC file number 333-63769)
3.2 Bylaws of the Company are incorporated by reference to exhibit
3(ii) of the Company's Form 8-K filed July 5, 2006 (SEC file
number 000-51166)
10.1 Loan Agreement between Community Shores Bank Corporation and
Fifth Third Bank dated September 7, 2007
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
32.2 Section 1350 Certification of Chief Financial Officer
-29-