10KSB 1 k25316e10ksb.txt ANNUAL REPORT OF SMALL BUSINESS DATED DECEMBER 31, 2007 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT 0F 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007 COMMISSION FILE NUMBER 333-135107 LOTUS BANCORP, INC (Exact name of registrant as specified in its charter) MICHIGAN 20-2377468 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.)
45650 GRAND RIVER AVENUE, NOVI, MI 48374 (Address of principal executive offices, including zip code) (248) 735-1000 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None Check whether the issuer is not required to file reports pursuant to Section 13 of 15(d) of the Exchange Act: [ ] 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of Form 10-KSB or any amendment of this Form 10-KSB. [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] The issuer's revenues for the most recent fiscal year ending December 31, 2007 were $878,536. The aggregate market value of the voting and non-voting common equity held by non-affiliates as of March 24, 2008 was $13,899,650. The number of shares outstanding of the Issuer's Common Stock, $0.01 par value, as of March 24, 2008 was 1,389,965 shares. DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS This report contains forward looking statements throughout that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about the Company and the Bank. 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 that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Actual results and outcomes may materially differ from what may be expressed or forecasted in the 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 that could cause actual results to differ materially from the results anticipated of projected include, but are not limited to the following: expected cost savings and synergies from our acquisition strategies may not be realized within the expected timeframes, and costs or difficulties related to integration matters might be greater than expected; expenses associated with the implementation or our trust and wealth management services might be greater than expected, whether due to possible need to hire more employees than anticipated or other costs incurred in excess of budgeted amounts; the credit risks of lending activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses; competitive pressures among depository institutions; interest rate movements and their impact on customer behavior and net interest margin; the impact of repricing and competitor's pricing initiatives on loan and deposit products; the ability to adapt successfully to technological changes to meet customers' needs and development in the marketplace; our ability to access cost-effective funding; changes in financial markets; changes in economic conditions in general and particularly as related to the automotive and related industries in the Detroit metropolitan area; new legislation or regulatory changes, including but not limited to changes in federal and/or state tax laws or interpretations thereof by taxing authorities; changes in accounting principles, policies or guidelines; and our future acquisitions of other depository institutions or lines of business. 2 INDEX PART I ITEM 1. DESCRIPTION OF BUSINESS. ITEM 2. DESCRIPTION OF PROPERTY. ITEM 3. LEGAL PROCEEDINGS. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. PART II ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION. ITEM 7. FINANCIAL STATEMENTS. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. ITEM 8A(T). CONTROLS AND PROCEDURES. ITEM 8B. OTHER INFORMATION. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT. ITEM 10. EXECUTIVE COMPENSATION. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. ITEM 13. EXHIBITS. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES. SIGNATURES
3 PART 1 ITEM 1. DESCRIPTION OF BUSINESS OVERVIEW Lotus Bancorp, Inc. (formerly known as City Central Bancorp, Inc.)(the "Company") was organized as a Michigan corporation on October 27, 2004 to serve as a bank holding company for Lotus Bank (the "Bank"). The Company received approval from the Federal Reserve Bank of Chicago on February 2, 2007 to become a bank holding company upon the acquisition of 100% of the common stock of Lotus Bank. The Company has no material business operations other than owning and managing the Bank, and has no plans for other business operations in the foreseeable future. In January of 2006, the organizers of the Bank filed applications with the Federal Deposit Insurance Corporation (FDIC) and the Michigan Office of Financial and Insurance Services (OFIS) for federal deposit insurance and a state banking charter, respectively. The Bank was required to obtain preliminary regulatory approvals from the FDIC and OFIS; however, these regulatory approvals were subject to certain conditions that the Bank had to satisfy before receiving a license to commence banking operations, which included: (1) capitalizing the Bank with at least $10.10 million, and (2) implementing appropriate banking policies and procedures. The Bank received these final regulatory approvals on February 5, 2007 by satisfying the above requirements, and commenced banking operations on February 28, 2007. The Company commenced its initial public offering on September 28, 2006 to raise the capital required to capitalize Lotus Bank. On February 26, 2007, the Company broke escrow in the amount of $12,769,358, consisting of $12,582,050 in stock subscriptions received plus $187,308 in accrued interest receivable. On February 27, 2007, the Company capitalized the Bank by downstreaming $10,500,000 into its capital accounts. Early in the third quarter of 2007, the Company closed on the remaining portion of its equity offering of $1,317,600, bringing its total equity to $13,899,650. PHILOSOPHY AND STRATEGY Lotus Bank operates as a full-service community bank headquartered in Novi, Michigan. The Bank offers a full range of sophisticated commercial and consumer banking products to small and medium-sized businesses, licensed professionals and consumers, while emphasizing a unique and personalized service experience, customized and tailored to fit the needs of its clients. To carry out this philosophy, the Bank's business strategy involves the following: - Capitalizing on the diverse community involvement, professional expertise and personal and business contacts of its organizers and executive officers; - Hiring and retaining qualified and experienced banking personnel; - Providing individualized attention with consistent, locally-based decision making authority; - Utilizing technology and strategic outsourcing to provide a wide array of convenient products and services; - Operating from a highly visible and accessible banking office in close proximity to a concentration of targeted commercial businesses, professionals and consumers; - Encouraging our shareholders to become customers by offering additional incentives; - Attracting its initial customer base by offering competitive interest rates on deposit accounts; and - Implementing a strong and effective marketing program. MARKET OPPORTUNITIES Primary service areas. Lotus Bank's primary service area is Oakland County, Michigan generally, and the cities of Novi, Farmington, Farmington Hills, West Bloomfield, Wixom and Commerce Township specifically. The Bank operates out of temporary facilities located at 45650 Grand River Avenue, Novi, Michigan until it can relocate to its permanent facility at 12 Mile and Dixon Roads in Novi. Lotus Bank draws most of its customer base from and within its primary service areas. Oakland County offers a stable population and is one of the most affluent counties in the country in terms of per capita income. Additionally, Lotus Bank focuses on serving the banking needs of the Asian-Indian community through specific target marketing efforts. Local economy. The Novi market is undergoing positive economic change and is capitalizing on the opportunities associated with such a change. Two significant suburban hospital expansions within a three mile radius of the Bank's facility are 4 investing $550 million into the local economy; the spin-off economic activity associated with these developments include medical office, medical provider, financial services and technology sector expansion. We believe that these economic activities in the Bank's primary banking market make it less likely for the Bank to be impacted by industry-specific economic conditions, particularly those manufacturing related, than would be the case in adjoining markets. The Novi area has maintained a stable population over the last decade, and is projected to grow at a rate of .31% per year over the next several years, reaching approximately 177,406 residents by 2010. The median household income in the Bank's primary service area is $106,494, with an average income level nearly twice that of the State of Michigan. Additionally, over 25% of the residences in the Novi area have been built since 1990. All of the projected growth rates and statistics are based on forecasts developed by Claritas. Substantially all of the Bank's business is concentrated in Southeast Michigan. The Southeast Michigan region is presently characterized by a weakened manufacturing economy, high levels of unemployment, high inventories of unsold residential housing, declining real estate values and increasing borrower defaults. The Bank's results of operations may be materially and adversely affected by changes in prevailing economic conditions, including declines in real estate market values, changes in interest rates, and the monetary and fiscal policies of the federal government. The Bank's profitability is, in part, dependent on the spread between the interest rates the Bank earns on investments and loans and the interest rates the Bank pays on deposits and other interest-bearing liabilities. The Bank's net interest spread and margin will be affected by general economic conditions and other factors beyond the Bank's control that influence market interest rates. In addition, the Bank has a significant concentration of loans to individuals and businesses in its primary market area and any decline in the economy of this area could have a material adverse effect on the Bank and the Company. Competition. The market for financial services is rapidly changing, intensely competitive, and likely to become more competitive as the number and types of market entrants increase. Lotus Bank will compete for both lending and deposit business with other commercial banks, thrifts, credit unions, finance companies, mutual funds, insurance companies, mortgage bankers and brokers, brokerage and investment banking firms, asset-based non-bank lenders, government agencies and others that may offer more attractive financing alternatives than the Bank. Many of these competitors are headquartered out-of-state. Because much of the competition's decision making is not local, there is the perception that a lack of consistency exists amongst these firms' local leadership. Through our local ownership and leadership, we believe that there is a significant opportunity for Lotus Bank to acquire market share from our competition by offering superior customer service and local decision making to small and medium-sized local businesses and consumers. We recognize that in order to effectively execute this strategy, our relative lack of resources as compared to our competition may require Lotus Bank to offer higher interest rates to attract depositors and offer lower lending rates to attract borrowers. BUSINESS STRATEGY Management philosophy. Lotus Bank is a full service commercial bank focusing on community involvement and highly personalized service while providing small and medium-sized business, licensed professionals and individuals competitive and sophisticated financial products typically offered by larger financial institutions. The Bank distinguishes itself from competitors through this strategy, and endeavors to hire the most qualified and experienced people in the market to execute the Bank's commitment to customer service. Accordingly, the Bank will implement the following operating and growth strategies: Operating strategy. In order to achieve the high level of customer service that we believe will be necessary to attract customers and to develop Lotus Bank's reputation as a local bank with a community focus, the following operating strategy will be employed: - Experienced Senior Management. Lotus Bank's proposed senior management team possesses extensive experience in the banking industry, as well as substantial business and banking contacts in our primary service area. Satish Jasti, the Bank's President & CEO, has over twenty-four years of banking experience, as does Richard Bauer, the Bank's Executive Vice President & CFO. Christer D. Lucander, the Bank's Executive Vice President & CLO, has over 23 years of experience in the local banking market. - Quality employees. Lotus Bank strives to hire only seasoned and highly trained staff. The Bank leverages its technological advantage by training its staff to anticipate and answer questions about its products and services by having all of the customer's relationship information at the employee's fingertips. - Community-oriented board of directors. All of Lotus Bank's directors are experienced bankers, licensed professionals or local business and community leaders. Many of its directors are residents of our primary service area, and all have significant business ties to the region, enabling them to be proactive in and responsive to the needs of the community. 5 Additionally, the board of directors represents a wide range of business experience and community involvement. We expect that the board of directors will attract substantial business and banking prospects to Lotus Bank through their extensive network personal and business affiliations. - Visible banking center. Lotus Bank's headquarters building will be constructed at the intersection of 12 Mile and Dixon Roads, a highly visible site located near major retail and commercial centers of the area and in close proximity to heavily traveled traffic arteries. This building will give the Bank a striking and highly visible presence in a market dominated by out-of-state competitors, and will enhance the Bank's image as a strong competitor. - Individual customer focus. Lotus Bank focuses on providing superior individual service and attention to our target customer base, which will include the Asian-Indian and local businesses, professionals and individuals. This focus allows the Bank's employees to respond more quickly and attentively to product and credit requests by developing a personal knowledge of the customer. Our products and services are delivered personally through technological and non-technological delivery systems that are effective and state-of-the-art. Lotus Bank clients enjoy relationships with the Bank's senior officers, directors and staff, and are offered technologically advanced banking products such as online banking and cash management and electronic remote deposit capture. - Financial and information center. Lotus Bank serves as a financial and informational center for the communities it serves. It has committed to sponsor an annual chamber of commerce economic luncheon, is active in other local associations whose aim is to discuss common business interests and networking, and has adopted an area elementary school where Lotus Bank employees will educate the students in savings and other financial management habits. - Marketing and advertising. Lotus Bank has engaged a highly creative and qualified firm to assist it in executing and guiding its marketing efforts to the community. The firm has developed a unique and distinctive image and approach that Lotus Bank will use to effectively distribute its products and services. Growth strategy. Because we believe that the growth and expansion of the Bank's operations is integral to our success, the following are the Bank's growth strategies: - Capitalize on community orientation. Lotus Bank capitalizes on its reputation as an independent, locally-owned and based community bank to attract small and medium-sized businesses, licensed professionals, and individuals that may be underserved by larger banking institutions in our primary service area. - Emphasize local decision-making. The Bank emphasizes local decision-making by experienced bankers. This helps Lotus Bank attract local businesses and service-minded customers. - Attract experienced lending professionals. Lotus Bank seeks to hire experienced, well trained lending professionals capable of soliciting loan business immediately. - Be a low-cost provider of products and services. The Bank's range of services, pricing strategies, interest rates earned and paid, and hours of operation are all structured to attract its target customers and increase its market share. Additionally, Lotus Bank passes on to its customers low overhead costs in the form of reduced fees on its products, especially its deposit products. LENDING SERVICES Lending policy. Lotus Bank offers a full range of lending products, including commercial loans for small and medium-sized businesses and professionals, real estate loans to businesses and individuals, and loans to consumers. The Bank understands that it competes for these loans against competitors who are well established in its primary service area, and who have greater resources and legal lending limits. As a result, Lotus Bank initially is offering more flexible pricing and terms to attract borrowers. We feel a quick response to credit requests helps to mitigate any competitive disadvantage that may exist between Lotus Bank and other financial institutions. The Bank's loan approval policies provides for various levels of officer lending authority. When the amount of total loans to a single borrower exceeds that individual officer's lending authority, an officer with a higher lending limit or Lotus Bank's management loan committee, or in certain cases, the Bank's board of director's loan committee, may approve the request. The Bank will not make any loans to any of its directors or executive officers unless the board of directors, excluding the interested party, first approves the loan, and the terms of the loan are no more favorable than would be available to any comparable borrower. Lending limits. The Bank's lending activities are subject to a variety of lending limits. Differing limits apply depending on the type of loan or the nature of the borrower, including the borrower's relationship to the Bank. In general, however, Lotus Bank will be able to loan any one borrower a maximum amount equal to either: - 15% of the Bank's capital and surplus; or 6 - Upon 2/3's vote of the bank's board of directors, 25% of its capital and surplus. These legal limits will increase or decrease as our capital accounts increase or decrease as a result of its earnings or losses, among other reasons. Credit risks. The principal economic risk associated with each category of loans the Lotus Bank makes is the creditworthiness of the borrower. Borrower creditworthiness is affected by general economic conditions and the strength of the relative business market segment. General economic factors affecting a borrowers ability to repay include inflation and employment rates, as well as factors affecting a borrowers own customers, suppliers and employees. The well-established lending institutions in our primary service area are likely to make proportionately more loans to medium and large-sized businesses than Lotus Bank will make. The majority of the loans that Lotus Bank makes are to small and medium-sized businesses, professionals and consumers that may be less able to withstand competitive, economic and financial pressures than larger borrowers. Real estate loans. Lotus Bank makes commercial real estate loans, construction and development loans, and residential real estate loans. The following is a description of each of the major categories of real estate loans the Bank make and the risks associated with each class of loan: - Commercial real estate. Commercial real estate loan terms generally are limited to five years or less through maturity, call provision, or other re-pricing provision. Payments may be structured on a longer amortization basis. Interest rates may be fixed or variable, although rates typically will not be fixed for a period exceeding the loans maturity or call provision. Lotus Bank generally charges an origination fee for its services. The Bank generally requires personal guarantees from the principal owners of the property, supported by a review by Bank management of the principal owners' personal financial statements. Risks associated with commercial real estate loans include fluctuations in the value of the real estate, new job creation trends, tenant vacancy rates and the quality of the borrower's management. The Bank limits its risk by analyzing borrowers' cash flow and collateral value on an ongoing basis. - Construction and development loans. Lotus Bank will consider making owner-occupied construction loans with a pre-approved take-out loan. The Bank will also consider making construction and development loans on a pre-sold basis, not to exceed six months, with renewals and extensions to be made in six month increments. The ratio of principal to the value of the collateral as established by independent appraisal typically will not exceed industry standards. Loan proceeds will be disbursed based on the percentage of completion and only after the project has been inspected by an experienced construction lender or third party inspector. Risks associated with construction loans include fluctuations in the value of real estate and new job creation trends. - Residential real estate. The Bank's residential real estate loans consists of residential second mortgage and home equity line of credit loans, residential construction loans and traditional mortgage lending for one-to-four family residences. Lotus Bank expects that any long term fixed rate mortgages will be underwritten for resale in the secondary mortgage market. All loans are made in accordance with Lotus Bank's appraisal policy with the ratio of loan principal to the value of collateral as established by independent appraisal in the range of 75-80%, depending on the type of loan. Should this ratio be above 80%, private mortgage insurance is required. The Bank believes that these loan to value ratios are sufficient to compensate for fluctuations in real estate market values and to minimize losses that could result from a downturn in the residential real estate market. Commercial loans. Loans for commercial purposes in various lines of businesses are one of the components of the Bank's loan portfolio. The target commercial loan markets are retail establishments, licensed professional companies, and small to medium-sized businesses. The terms of these loans vary by purpose and type of underlying collateral, if any. The commercial loans are underwritten primarily on the basis of the borrower's ability to service the loan from income. The Bank typically makes equipment loans for a term of five years or less at fixed or variable rates, with the loan fully amortized over the term. Loans to support working capital typically have terms not exceeding one year on a revolving basis, or 120 days on a single pay basis, and are collateralized by borrower assets or a personal guarantee. For loans secured by accounts receivable or inventory, principal is typically repaid as the assets securing the loan are converted into cash, and for loans secured by other types of collateral, principal is typically due at maturity. The quality of the commercial borrower's management and its ability to both properly evaluate changes in the supply and demand characteristics affecting its markets for products and services and to effectively respond to such changes are significant factors in evaluating the risk of making such loans. Consumer loans. Lotus Bank makes a variety of loans to individuals for personal, family and household purposes, including secured and unsecured installment and term loans. Repayment of consumer loans depends on the borrower's financial stability and is more likely to be adversely affected by divorce, job loss, illness and personal hardships than are characteristic in the 7 repayment of other types of loans. Because many consumer loans are secured by depreciable assets such as cars or boats, the loan is amortized over the useful life of the asset. The loan officer will review the borrower's past credit history, past income level, debt history and, when applicable, cash flow, and determine the impact of all of these factors on the ability of the borrower to make future payments as agreed. INVESTMENTS In addition to loans, Lotus Bank makes other investments primarily in obligations of the United States or obligations guaranteed as to principal and interest by the United States and other taxable securities. No investment in any of those instruments will exceed any applicable limitation imposed by policy, law or regulation. The asset-liability management committee reviews the investment portfolio on an ongoing basis in order to ensure that the investments conform to the policy as set forth by the Bank's board of directors. ASSET AND LIABILITY MANAGEMENT The asset and liability management committee oversees Lotus Bank's assets and liabilities and strives to provide a stable, optimized net interest margin, adequate liquidity and a profitable after-tax return on assets and return on equity. The committee conducts these functions within the framework of written loan and investment policies of the Bank. The committee attempts to maintain a balanced position between rate sensitive assets and rate sensitive liabilities. Specifically, it charts assets and liabilities on a matrix by maturity or re-pricing opportunity and endeavors to manage any gaps in these ranges. DEPOSIT SERVICES Lotus Bank seeks to establish a broad base of core deposits, including savings, checking, NOW, and money market accounts, as well as a wide variety of certificate of deposit and individual retirement accounts. The Bank intends to initially leverage our original shareholder base, which is comprised of residents of our primary service area, into a source of core deposits. In addition, the Bank will implement an aggressive marketing and advertising campaign in its primary service area featuring a broad range of low cost products at competitive interest rates and terms. The targeted sources of deposits are residents of, professionals in, and businesses and their employees located in our primary service area. Lotus Bank obtains these deposits through personal solicitation by its officers and directors, direct mail solicitations and advertisements placed in the local media. OTHER BANKING SERVICES Other anticipated banking services include, cashier's checks, traveler's checks, direct deposit, wire transfer, international money transfer, bank by mail, Internet banking, automated bill pay, remote deposit capture, automated teller machines, and ATM/debit cards. The Bank is associated with nationwide networks of automated teller machines in order to provide its customers with convenient cash access throughout Michigan and other regions. Lotus Bank also plans to offer credit card and merchant credit card processing through a third-party or correspondent bank relationship, with the Bank acting as agent. The Bank does not plan to exercise trust powers and may do so in the future only with prior regulatory approval. EMPLOYEES Lotus Bank's success depends, in part, on its ability to attract, retain and motivate highly qualified management and staff, for whom competition is rigorous. As of March 24, 2008, the Company has no employees, and the Bank has 11 employees, of whom 10 are full time employees. SUPERVISION AND REGULATION GENERAL The growth and earnings performance of the Company and the Bank can be affected not only by management decisions and general economic conditions, but also by the policies of various governmental regulatory authorities including, but not limited to, the Board of Governors of the Federal Reserve System (the "Federal Reserve"), the Federal Deposit Insurance Corporation (the "FDIC"), the Michigan Office of Financial and Insurance Services (the "OFIS"), the Internal Revenue Service and state taxing authorities. Financial institutions and their holding companies are extensively regulated under federal and state law. The effect of such statutes, regulations and policies can be significant, and cannot be predicted with a high degree of certainty. Federal and state laws and regulations generally applicable to financial institutions, such as the Company and the Bank, regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of 8 supervision and regulation applicable to the Company and the Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC's deposit insurance funds and the depositors, rather than the shareholders, of financial institutions. The following references to material statutes and regulations affecting the Company and the Bank are brief summaries and do not purport to be complete, and are qualified in their entirety by reference to such statues and regulations. Any change in applicable law or regulations may have a material effect on the business of the Company and the Bank. THE COMPANY GENERAL. The Company, as the sole shareholder of the Bank, is a bank holding company. As a bank holding company, the Company is required to register with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act, as amended (the "BHCA"). In accordance with Federal Reserve policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Company might not do so absent such policy. Under the BHCA, the Company is subject to periodic examination by the Federal Reserve and is required to file periodic reports of its operations and such additional information as the Federal Reserve may require. INVESTMENTS AND ACTIVITIES. Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company. The Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States without regard to geographic restrictions or reciprocity requirements imposed by state law, but subject to certain conditions, including limitations on the aggregate amount of deposits that may be held by the acquiring holding company and all of its insured depository institution affiliates. The BHCA limits the activities of a bank holding company that has not qualified as a financial holding company to banking and the management of banking organizations, and to certain non-banking activities. These non-banking activities include those activities that the Federal Reserve found, by order or regulation as of the day prior to enactment of the Gramm-Leach-Bliley Act (the "GLB Act") on November 11, 1999, to be so closely related to banking or managing or controlling banks as to be a proper incident to those activities. Such non-banking activities include, among other things: operating a mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; and providing securities brokerage services for customers. A bank holding company whose subsidiary depository institutions all are well-capitalized and well-managed and who have Community Investment Act ratings of at least "satisfactory" may elect to become a financial holding company. A financial holding company is permitted to engage in a broader range of activities than are permitted to bank holding companies. Those expanded activities include any activity which the Federal Reserve (in certain instances in consultation with the Department of the Treasury) determines, by order or regulation, to be financial in nature or incidental to such financial activity, or to be complementary to a financial activity and not to pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. Such expanded activities include, among others: insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability or death, or issuing annuities, and acting as principal, agent, or broker for such purposes; providing financial, investment, or economic advisory services, including advising a mutual fund; and underwriting, dealing in, or making a market in securities. Federal legislation also prohibits the acquisition of control of a bank holding company, such as the Company, by a person or a group of persons acting in concert, without prior notice to the Federal Reserve. Control is defined in certain cases as the acquisition of 10% of the outstanding shares of a bank holding company. CAPITAL REQUIREMENTS. The Federal Reserve uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guideline levels, a bank holding company may, among other things, be denied approval to acquire or establish additional banks or non-bank businesses. The Federal Reserve capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: a risk-based requirement expressed as a percentage of total risk-weighted assets, and a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least 4% must be Tier I capital (which consists principally of shareholders' equity). The 9 leverage requirement consists of a minimum ratio of Tier I capital to total assets of 3% for the most highly rated bank holding companies, with minimum requirements of 4% to 5% for all others. The risk-based and leverage standards presently used by the Federal Reserve are minimum requirements, and higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier I capital less all intangible assets), well above the minimum levels. THE BANK GENERAL. The Bank is a Michigan state-chartered bank, the deposit accounts of which are insured by the FDIC. As a state-chartered non-member bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the OFIS, as the chartering authority for state banks, and the FDIC, as administrator of the deposit insurance fund, and to the statutes and regulations administered by the OFIS and the FDIC governing such matters as capital standards, mergers, establishment of branch offices, subsidiary investments and activities and general investment authority. The Bank is required to file reports with the OFIS and the FDIC concerning its activities and financial condition and is required to obtain regulatory approvals prior to entering into certain transactions, including mergers with, or acquisitions of, other financial institutions. BUSINESS ACTIVITIES. State Bank Activities - Under federal law and FDIC regulations, FDIC insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount that are not permissible for a national bank. Federal law and FDIC regulations also prohibit FDIC insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund. The GLB Act also authorizes state insured banks to engage in financial activities, through subsidiaries, similar to the activities permitted for financial holding companies. If a state bank wants to establish a subsidiary engaged in financial activities, it must meet certain criteria, including that it and all of its affiliated depository institutions are well-capitalized and have a Community Reinvestment Act rating of at least "satisfactory" and that it is well-managed. There are capital deduction and financial statement requirements and financial and operational safeguards that apply to subsidiaries engaged in financial activities. Such a subsidiary is considered to be an affiliate of the bank and there are limitations on certain transactions between a bank and a subsidiary engaged in financial activities of the same type that apply to transactions with a bank holding company and its subsidiaries. BRANCHING AUTHORITY. Michigan banks, such as the Bank, have the authority under Michigan law to establish branches in any state, including Michigan, the District of Columbia, a territory or protectorate of the United States or a foreign country, subject to the receipt of all required regulatory approvals. Under federal law banks may establish interstate branch networks through merger or consolidation with other banks without regard to whether such activity is contrary to state law. The establishment of de novo interstate branches or the acquisition of individual branches of a bank in another state (rather than the merger or consolidation with an out-of-state bank) is allowed only if specifically authorized by the law of the state where the branch will be established or acquired. Michigan law permits both U.S. and non-U.S. banks to establish branches in Michigan. The Michigan Banking Code permits, in appropriate circumstances and with the approval of the Commissioner, (1) sale by a Michigan bank of branches to an FDIC-insured bank, savings bank or savings and loan association located in a state in which a Michigan bank could purchase branches of the purchasing entity, (2) establishment of branches in Michigan by FDIC-insured banks located in other states, the District of Columbia or U.S. territories or protectorates having laws permitting a Michigan bank to establish a branch in such jurisdiction, and (3) establishment by foreign banks of branches located in Michigan. LOANS TO ONE BORROWER. Under Michigan law, a bank's total loans and extensions of credit and leases to one person is limited to 15% of the bank's capital and surplus, subject to several exceptions. This limit may be increased to 25% of the bank's capital and surplus upon approval by a 2/3 vote of its board of directors. Certain loans, including loans secured by bonds or other instruments of the United States and fully guaranteed by the United States as to principal and interest, are not subject to the limit just referenced. In addition, certain loans, including loans arising from the discount of nonnegotiable consumer paper which carries a full recourse endorsement or unconditional guaranty of the person transferring the paper, are subject to a higher limit of 30% of capital and surplus. ENFORCEMENT. The OFIS and FDIC each have enforcement authority with respect to the Bank. The Commissioner of the OFIS has the authority to issue cease and desist orders to address unsafe and unsound practices and actual or imminent violations of law 10 and to remove from office bank directors and officers who engage in unsafe and unsound banking practices and who violate applicable laws, orders, or rules. The Commissioner of the OFIS also has authority in certain cases to take steps for the appointment of a receiver or conservator of a bank. The FDIC has similar broad authority, including authority to bring enforcement actions against all "institution-affiliated parties" (including shareholders, directors, officers, employees, attorneys, consultants, appraisers and accountants) who knowingly or recklessly participate in any violation of law or regulation or any breach of fiduciary duty, or other unsafe or unsound practice likely to cause financial loss to, or otherwise have an adverse effect on, an insured institution. Civil penalties under federal law cover a wide range of violations and actions. Criminal penalties for most financial institution crimes include monetary fines and imprisonment. In addition, the FDIC has substantial discretion to impose enforcement action on banks that fail to comply with its regulatory requirements, particularly with respect to capital levels. Possible enforcement actions range from requiring the preparation of a capital plan or imposition of a capital directive, to receivership, conservatorship, or the termination of deposit insurance. ASSESSMENTS AND FEES. The Bank pays a supervisory fee to the OFIS of not less than $1,000 and not more than 25 cents for each $1,000 of total assets. This fee is invoiced prior to July 1 each year and is due no later than August 15. The OFIS imposes additional fees, in addition to those charged for normal supervision, for applications, special evaluations and analyses, and examinations. REGULATORY CAPITAL REQUIREMENTS. The Bank is required to comply with capital adequacy standards set by the FDIC. The FDIC may establish higher minimum requirements if, for example, a bank has previously received special attention or has a high susceptibility to interest rate risk. Banks with capital ratios below the required minimum are subject to certain administrative actions. More than one capital adequacy standard applies, and all applicable standards must be satisfied for an institution to be considered to be in compliance. There are three basic measures of capital adequacy: a total risk-based capital measure, a Tier 1 risk-based capital ratio; and a leverage ratio. The risk-based framework was adopted to assist in the assessment of capital adequacy of financial institutions by, (i) making regulatory capital requirements more sensitive to differences in risk profiles among organizations; (ii) introducing off-balance-sheet items into the assessment of capital adequacy; (iii) reducing the disincentive to holding liquid, low-risk assets; and (iv) achieving greater consistency in evaluation of capital adequacy of major banking organizations throughout the world. The risk-based guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning assets and off-balance sheet items to different risk categories. An institution's risk-based capital ratios are calculated by dividing its qualifying capital by its risk-weighted assets. Qualifying capital consists of two types of capital components: "core capital elements" (or Tier 1 capital) and "supplementary capital elements" (or Tier 2 capital). Tier 1 capital is generally defined as the sum of core capital elements less goodwill and other intangibles. Core capital elements consist of (i) common shareholders' equity, (ii) noncumulative perpetual preferred stock (subject to certain limitations), and (iii) minority interests in the equity capital accounts of consolidated subsidiaries. Tier 2 capital consists of (i) allowance for loan and lease losses (subject to certain limitations); (ii) perpetual preferred stock which does not qualify as Tier 1 capital (subject to certain conditions); (iii) hybrid capital instruments and mandatory convertible debt securities; (iv) term subordinated debt and intermediate term preferred stock (subject to limitations); and (v) net unrealized holding gains on equity securities. Under current capital adequacy standards, the Bank must meet a minimum ratio of qualifying total capital to risk-weighted assets of 8%. Of that ratio, at least half, or 4%, must be in the form of Tier 1 capital. The Bank must also meet a leverage capital requirement. In general, the minimum leverage capital requirement is not less than 3% Tier 1 capital to total assets if the bank has the highest regulatory rating and is not anticipating or experiencing any significant growth. All other banks should have a minimum leverage capital ratio of 100 to 200 basis points higher and thus a minimum leverage capital ratio of not less than 4%. PROMPT CORRECTIVE REGULATORY ACTION. The FDIC is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, a bank is considered "well capitalized" if its risk-based capital ratio is at least 10%, its Tier 1 risk-based capital ratio is at least 6%, its leverage ratio is at least 5%, and the bank is not subject to any written agreement, order, or directive by the FDIC. A bank generally is considered "adequately capitalized" if it does not meet each of the standards for well-capitalized institutions, and its risk-based capital ratio is at least 8%, its Tier 1 risk-based capital ratio is at least 4%, and its leverage ratio is at least 4% (or 3% if the institution receives the highest rating under the Uniform Financial Institution Rating System). A bank that has a risk-based capital ratio less than 8%, or a Tier 1 risk-based capital ratio less than 4%, or a leverage ratio less than 4% (3% or less for 11 institutions with the highest rating under the Uniform Financial Institution Rating System) is considered to be "undercapitalized." A bank that has a risk-based capital ratio less than 6%, or a Tier 1 capital ratio less than 3%, or a leverage ratio less than 3% is considered to be "significantly undercapitalized," and a bank is considered "critically undercapitalized" if its ratio of tangible equity to total assets is equal to or less than 2%. Subject to a narrow exception, the FDIC is required to appoint a receiver or conservator for a bank that is "critically undercapitalized." In addition, a capital restoration plan must be filed with the FDIC within 45 days of the date a bank receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by each company that controls a bank that submits such a plan, up to an amount equal to 5% of the bank's assets at the time it was notified regarding its deficient capital status. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions, and expansion. The FDIC could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. DEPOSIT INSURANCE. The Bank's deposits are insured up to applicable limitations by a deposit insurance fund administered by the FDIC. Following the adoption of the Federal Deposit Insurance Reform Act of 2005, the FDIC has the opportunity, through its rulemaking authority, to better price deposit insurance for risk than was previously authorized. The FDIC adopted regulations effective January 1, 2007 that created a new system of risk-based assessments. Under the regulations there are four risk categories, and each insured institution will be assigned to a risk category based on capital levels and supervisory ratings. Well-capitalized institutions with CAMELS composite ratings of 1 or 2 will be placed in Risk Category I while other institutions will be placed in Risk Categories II, III or IV depending on their capital levels and CAMELS composite ratings. The current assessment rates established by the FDIC provide that the highest rated institutions, those in Risk Category I, will pay premiums of between 05% and .07% of deposits and the lowest rated institutions, those in Risk Category IV, will pay premiums of .43% of deposits. The assessment rates may be changed by the FDIC as necessary to maintain the insurance fund at the reserve ratio designated by the FDIC, which currently is 1.25% of insured deposits. The FDIC may set the reserve ratio annually at between 1.15% and 1.50% of insured deposits. Deposit insurance assessments will be collected for a quarter at the end of the next quarter. Assessments will be based on deposit balances at the end of the quarter, except for institutions with $1 billion or more in assets and any institution that becomes insured on or after January 1, 2007, such as the Bank, which will have their assessment base determined using average daily balances of insured deposits. PAYMENT OF DIVIDENDS BY THE BANK. There are state and federal requirements limiting the amount of dividends which the Bank may pay. Generally, a bank's payment of cash dividends must be consistent with its capital needs, asset quality, and overall financial condition. Due to FDIC requirements, it is expected that the Bank will not be permitted to make dividend payments to the Company during the first three (3) years of the Bank's operations. Additionally, OFIS and the FDIC have the authority to prohibit the Bank from engaging in any business practice (including the payment of dividends) which they consider to be unsafe or unsound. Under Michigan law, the payment of dividends is subject to several additional restrictions. The Bank cannot declare or pay a cash dividend or dividend in kind unless the Bank will have a surplus amounting to not less than 20% of its capital after payment of the dividend. The Bank will be required to transfer 10% of net income to surplus until its surplus is equal to its capital before the declaration of any cash dividend or dividend in kind. In addition, the Bank may pay dividends only out of net income then on hand, after deducting its losses and bad debts. These limitations can affect the Bank's ability to pay dividends. LOANS TO DIRECTORS, EXECUTIVE OFFICERS, AND PRINCIPAL SHAREHOLDERS. Under FDIC regulations, the Bank's authority to extend credit to executive officers, directors, and principal shareholders is subject to substantially the same restrictions set forth in Federal Reserve Regulation O. Among other things, Regulation O (i) requires that any such loans be made on terms substantially similar to those offered to nonaffiliated individuals, (ii) places limits on the amount of loans the Bank may make to such persons based, in part, on the Bank's capital position, and (iii) requires that certain approval procedures be followed in connection with such loans. CERTAIN TRANSACTIONS WITH RELATED PARTIES. Under Michigan law, the Bank may purchase securities or other property from a director, or from an entity of which the director is an officer, manager, director, owner, employee, or agent, only if such purchase (i) is made in the ordinary course of business, (ii) is on terms not less favorable to the Bank than terms offered by others, and (iii) the purchase is authorized by a majority of the board of directors not interested in the sale. The Bank may also sell securities or other property to its directors, subject to the same restrictions (except in the case of a sale by the Bank, the terms may not be more favorable to the director than those offered to others). In addition, the Bank is subject to certain restrictions imposed by federal law on extensions of credit to the Company and its non-bank subsidiaries, on investments in the stock or other securities of the Company and its non-bank subsidiaries, and on the acceptance of stock or other securities of the Company or its non-bank subsidiaries as collateral for loans. Various 12 transactions, including contracts, between the Bank and the Company or its non-bank subsidiaries must be on substantially the same terms as would be available to unrelated parties. STANDARDS FOR SAFETY AND SOUNDNESS. The FDIC has established safety and soundness standards applicable to the Bank regarding such matters as internal controls, loan documentation, credit underwriting, interest-rate risk exposure, asset growth, compensation and other benefits, and asset quality and earnings. If the Bank were to fail to meet these standards, the FDIC could require it to submit a written compliance plan describing the steps the Bank will take to correct the situation and the time within which such steps will be taken. The FDIC has authority to issue orders to secure adherence to the safety and soundness standards. RESERVE REQUIREMENT. Under a regulation promulgated by the Federal Reserve, depository institutions, including the Bank, are required to maintain non-interest earning reserves against a stated percentage of their transaction accounts, as follows: - for transaction accounts totaling $9.3 million or less, a reserve of 0%; and - for transaction accounts in excess of $9.3 million up to and including $43.9 million, a reserve of 3%; and - for transaction accounts totaling in excess of $43.9 million, a reserve requirement of $1.038 million plus 10% against that portion of the total transaction accounts greater than $43.9 million. The effect of maintaining the required non-interest earning reserve is to reduce the Bank's interest-earning assets. ITEM 2. DESCRIPTION OF PROPERTY. Lotus Bank is currently operating in a leased facility located at 45650 Grand River Avenue, Novi, Michigan 48374, which is on the north side of Grand River and west of Taft Road. This stretch of Grand River Avenue is a heavily traveled, five-lane state highway, near the Rock Financial Showplace. The lobby of the Bank is accessible through the parking lot. We are also nearing the final phase of construction permanent headquarters facility located near the intersection of 12 Mile and Dixon Roads in Novi. This distinctive bank building is being constructed on the front parcel of 2.5 acres of land that Lotus Bancorp, Inc. purchased in August of 2006. The building will front 12 Mile Road, across from the Fountainwalk Mall and adjacent to the Twelve Oaks Mall, and near two several-hundred unit residential developments. The construction on this facility is expected to be completed in April 2008, with occupancy shortly thereafter. The aggregate commitments under the lease are set forth in the notes to the audited financial statements included in this Form 10-KSB. The Bank owns its headquarters facility. When the headquarters facility is ready for occupancy, we will abandon the leased facility on Grand River Avenue. Management believes that the headquarters facility, at 5,200 square feet, will be sufficient to meet the business needs of the Company and the Bank. All facilities, whether purchased or leased, will be adequately covered by the appropriate insurances. ITEM 3. LEGAL PROCEEDINGS. There are no material pending legal proceedings to which the Company or the Bank is a party or to which any of its properties are subject, nor are there any material proceedings known to the Company in which any director, officer or affiliate, or any principal shareholder is a party or has an interest adverse to the Company or the Bank. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There were no matters submitted to the vote of our security holders during the fourth quarter of the fiscal year ended December 31, 2007. 13 PART II ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OR EQUITY SECURITIES. MARKET INFORMATION There is currently no established market for the common stock of the Company, and an active trading market is not likely to develop. The Company has future plans to list its common stock on the OTC Bulletin Board and expects at least one company to make a market in its shares. COMMON STOCK As of December 31, 2007, 1,389,965 shares of the Company's common stock were issued and outstanding, and there were approximately 220 shareholders of record. As of March 24, 2008, 1,389,965 shares of the Company's common stock were issued and outstanding. DIVIDENDS Because, as a holding company, the Company will initially conduct no material activities other than holding the common stock of the Bank, its ability to pay dividends will depend on the receipt of dividends from the Bank. Initially, the Company expects that the Bank will retain all of its earnings to support its operations and to expand its business. Additionally, the Company and the Bank are subject to significant regulatory restrictions on the payment of cash dividends. In light of these restrictions and the need to retain and build capital, neither the Company nor the Bank plans to pay dividends until the Bank becomes profitable and recovers any losses incurred during its initial operations. The payment of future dividends and the dividend policies of the Company and the Bank will depend on the earnings, capital requirements and financial condition of the Company and the Bank, as well as other factors that its respective boards of directors consider relevant. WARRANTS As of December 31, 2007, warrants to purchase up to 420,493 shares of the Company's common stock were outstanding, as follows:
Warrant Type Outstanding Terms ------------ ----------- ----- Shareholder 277,993 $12.50/share strike price; Three year term to expire February 27, 2010 Organizer 142,500 $10.00/share strike price; Ten year term to expire February 27, 2017 ------- Total 420,493 =======
As of March 24, 2008, warrants to purchase up to 420,493 shares of the Company's common stock were outstanding. Organizer and initial shareholder warrants to purchase fractional shares were not issued. Instead, we rounded down to the next whole number in calculating the number of warrants to issue to any shareholder. Holders of warrants will be able to profit from any rise in the market value of our common stock over the exercise price of the warrants because they will be able to purchase shares of our common stock at a price that is less than the then current market value. If the Bank's capital falls below the minimum level as required by the FDIC, we may be directed to require the shareholders to exercise or forfeit their warrants. RECENT SALES OF UNREGISTERED SECURITIES The Company has not sold any unregistered securities. SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES None. 14 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS The following discussion and analysis provides information which the Company believes is relevant to an assessment and understanding of the Company's results of operations and financial condition. This discussion should be read in conjunction with the financial statements and accompanying notes appearing in this report. OVERVIEW The Company is a Michigan corporation that was incorporated on October 27, 2004 to organize and serve as the holding company for a Michigan state bank, Lotus Bank (the "Bank"). The Bank is a full service commercial bank headquartered in Novi, Michigan, and serves the city of Novi, Michigan and the neighboring communities of Commerce Township, Farmington, Farmington Hills, Northville, West Bloomfield and Wixom, and offers a broad array of commercial and consumer banking products and services to small and medium-sized businesses, licensed professionals and individuals. On January 11, 2006, applications were filed with the Michigan Office of Financial and Insurance Services (OFIS) and with the Federal Deposit Insurance Corporation (FDIC) for permission to organize the Bank and for federal deposit insurance, respectively. The Bank received the regulatory approvals of the OFIS and FDIC; however, these regulatory approvals were subject to certain conditions that the Bank had to satisfy before receiving a license to commence banking operations, including; (1) capitalizing the Bank with at least $10.1 million after pre-opening expenses, and (2) instituting appropriate banking policies and procedures. These conditions were satisfied, and the Company capitalized the Bank by downstreaming $10,500,000 of proceeds from its initial public offering into the Bank's capital accounts on February 27, 2007; the Bank commenced banking operations on February 28, 2007. The Company filed a Registration Statement on Form SB-2 with the Securities and Exchange Commission (SEC) which Registration Statement became effective August 14, 2006. Pursuant to the Registration Statement, a minimum of 1,100,000 shares of the Company's stock, $.01 par value per share, and a maximum of 1,600,000 shares of common stock were registered for sale at an offering price of $10.00 per share. The Company raised a total of $13,899,650 and capitalized the Bank with $10,500,000. The results of operations depend largely on net interest income. Net interest income is the difference in interest income the Company earns on interest-earning assets, primarily commercial business, commercial real estate and consumer loans and federal funds sold, and the interest the Company pays on interest-bearing liabilities, primarily money market deposit accounts and certificates of deposit. Management strives to match the repricing characteristics of the interest-earning assets and interest-bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve. The results of operations may also be affected by local and general economic conditions. The largest section of our customer base is located in Oakland County, Michigan. The economic base of the County continues to diversify from the automotive service sector. While this trend continues, there have been significant economic difficulties caused throughout southeast Michigan as a result. Business operation downsizing, job cuts, high unemployment, declining real estate values and high rates of foreclosure, among other factors, have resulted in a challenging operating environment for many sectors of the Michigan economy, including the Michigan banking industry. Changes in the economy may affect the demand for commercial and consumer loans and related small business and retail banking products. This could have a significant impact on how the Company deploys earning assets. The competitive environment among other financial institutions and financial service providers and the Bank in the Oakland County market may affect the pricing levels of various deposit products. The competitive rates on deposit products may increase the relative cost of funds for the Company and thus negatively impact net interest income. The Company continues to see competitive deposit rates offered from local financial institutions in its market which could have the effect of increasing the cost of funds to a level higher than management projects. CRITICAL ACCOUNTING POLICIES ALLOWANCE FOR LOAN LOSSES The Company performs a detailed quarterly review of the allowance for credit losses. The Company evaluates those loans classified as substandard, under its internal risk system, on an individual basis for impairment under SFAS 114. The level and the allocation of the allowance are determined primarily on management's evaluation of collateral value, less the cost of disposal, for loans reviewed in this category. The remainder of the total loan portfolio is segmented into homogenous pools with similar risk characteristics for evaluation under SFAS 5. The Company uses factors such as historical portfolio losses 15 amongst peer group banks, national and local economic trends, and levels of delinquency to determine the appropriate level and allocation of the allowance for loans in this grouping. The Company's policy dictates that specifically identified credit losses be recognized immediately by a charge against the allowance for loan losses. The Bank is also required to maintain certain minimum levels of reserves during its first three years of operation based upon the business plan submitted as part of the regulatory approval process and based upon the order granting it permission to operate by the State of Michigan, Office of Financial and Insurance Services. Inherent risks and uncertainties related to determination of adequacy of the allowance for loan losses require management to depend on estimates, appraisals and evaluations of loans to prepare the analysis. Changes in economic conditions and the financial prospects of borrowers may result in changes to the estimates, appraisals and evaluations used. In addition, if circumstances and losses differ substantially from management's assumptions and estimates, the allowance for loan losses may not be sufficient to absorb all future losses and net income could be significantly impacted. PLAN OF OPERATION The Company's (and the Bank's) proposed main office will be located at the intersection of 12 Mile and Dixon Roads in Novi, Michigan. The Company expects construction of the main office to be completed in April 2008. The building will be a free standing facility of approximately 5,200 square feet. The Company is currently operating out of leased facilities located at 45650 Grand River Avenue, Novi, Michigan 48374. The Company has executed a one year lease agreement for approximately 2,200 square feet at this location. The lease commenced in September, 2006, expired in September, 2007, and has been a month-to-month lease thereafter. The Company used approximately $2,550,000 of the proceeds of its initial public offering to pay off a portion of the line of credit used to purchase the land, construct the facility, and purchase furniture, fixtures and equipment for its banking location. The Bank expects to hire up to 4 additional full-time equivalent employees to staff its banking office within the next twelve months, and the Company does not expect that it will have any employees who are not also employees of the Bank. The Bank has used the remainder of its capital proceeds for customer loans, investments and other general banking purposes. We believe that the Company's minimum initial public offering proceeds will enable the Bank to maintain a leverage capital ratio, which is a measure of core capital to average total assets, in excess of 8% for the first three years of operations as required by the FDIC. Accordingly, the Company does not anticipate raising additional capital during the 12 month period following its initial public offering. However, the Company cannot provide assurance that it will not need to raise additional capital within the next three years or over the next 12 month period. 16 SELECTED FINANCIAL INFORMATION The following information is of selected consolidated financial data as of the report date. Information shown for periods prior to 2007 is not comparable as the Company did not commence banking operations until February 27, 2007.
For the Year Ended December 31 ------------------------- 2007 2006 ----------- ---------- Total assets $19,282,000 $1,399,000 Gross loans 9,109,000 -- Allowance for loan losses 88,000 -- Total deposits 7,383,000 -- Borrowings -- 1,857,000 Shareholder's equity (deficit) 11,859,000 (685,000) Summary of Operations: Interest income 871,000 89,000 Interest expense 166,000 38,000 ----------- ---------- Net interest income 705,000 51,000 Provision for loan losses 88,000 -- Noninterest income 8,000 -- Noninterest expense 2,045,000 593,000 ----------- ---------- Income before taxes (1,420,000) (542,000) Provision for income taxes -- -- ----------- ---------- Net income $(1,420,000) $ (542,000) =========== ========== Per Share Data: Basic earnings $ (1.23) $ (541,796) Diluted earnings (1.23) (541,796) Dividends declared -- --
Selected Financial Ratios:
For the Year Ended December 31 -------------------- 2007 2006 ------ ------ Total nonperforming assets as a percentage of total assets -- n/a Total nonperforming loans as a percentage of total loans -- n/a Total allowance for loan losses as a percentage of total loans .97% n/a Return on average assets (8.32%) (38.73%) Return on average equity (11.81%) n/a Net interest margin 4.18% n/a Average equity to average assets 70.40% n/a
17 ASSETS At December 31, 2007, the Company's total assets were $19.3 million, an increase of $17.9 million from December 31, 2006. The growth came as the Company completed its stock offering, of which the first closing occurred on February 26, 2007 for $12.6 million and the second closing in early July for an additional $1.3 million for a total of $13.9 million in capital raised. The largest segment of asset growth for the year ended December 31, 2007 occurred in the loan portfolio as the Company began to deploy the equity raised by funding $9.1 million in loans during its first ten months of operation. Excess funds were maintained in Federal Funds sold. Federal Funds sold were $4.2 million at December 31, 2007. Due to the growth pattern during the Company's inception of banking operations, volatile credit markets in the latter part of 2007, and perceived demand for the Company's credit products, management deemed it prudent to maintain liquidity in Federal Funds sold rather than investing in various investment securities offering little, if any, yield advantage and restricting the Company's liquidity. Premises and equipment increased to $2.5 million as the Company commenced construction and purchased furniture, fixtures, computer equipment and software for its headquarters building. Construction of the headquarters is expected to be complete late in the first quarter of 2008. The largest portion of loan growth occurred in the commercial portfolio, including commercial real estate, which is consistent with the Company's commercial lending focus. At December 31, 2007, commercial loans totaled $6.7 million, consumer loans totaled $0.8 million, and residential mortgage and home equity loans totaled $1.6 million. The allowance for loan losses was $88,000 or 0.97% of average loans outstanding at December 31, 2007. There were no charge-offs or non-performing loans during the year. There were no loans more than 30 days past due as of December 31, 2007. Loans are placed in nonaccrual status when, in the opinion of management, uncertainty exists as to the ultimate collection of principal and interest. At December 31, 2007, there were no loans in nonaccrual status. Commercial loans are reported as being in nonaccrual status if: (a) they are maintained on a cash basis because of a deterioration in the financial position of the borrower, (b) payment in full of principal or interest is not expected, or (c) principal or interest has been in default for a period of 90 days or more. If it can be documented that the loan obligation is both well secured and in the process of collection, the loan may stay on accrual status. However, if the loan is not brought current before 120 days past due, the loan is reported as nonaccrual. A nonaccrual asset may be restored to accrual status when none of its principal or interest is due and unpaid, when it otherwise becomes well secured, or is in the process of collection. Management evaluates the condition of the loan portfolio on a quarterly basis to determine the adequacy of the allowance for loan losses. Management's evaluation of the allowance is further based on consideration of actual loss experience, the present and expected financial condition of borrowers, adequacy of collateral, industry concentrations within the portfolio, and general economic conditions. Management believes the present allowance is adequate, based on the broad list of considerations listed above. The primary risk element considered by management regarding each consumer and residential real estate loan is lack of timely payment. Management has a reporting system that monitors past due loans and has adopted policies to pursue its creditor's rights in order to preserve the bank's position. The primary risk elements concerning commercial and industrial and commercial real estate loans are the financial condition of the borrower, the sufficiency of collateral, and lack of timely payment. Management has a policy of requesting and reviewing annual financial statements from its commercial loan customers and periodically reviews the existence of collateral in its files. Although management believes that the allowance for loan losses is adequate to absorb losses as they arise, there can be no assurance that the Bank will not sustain losses in any given period that could be substantial in relation to the size of the allowance for loan losses. It must be understood that inherent risks and uncertainties related to the operation of a financial institution require management to depend on estimates, appraisals and evaluations of loans to prepare the Company's financial statements. Changes in economic conditions and the financial prospects of borrowers may result in changes to the estimates, appraisals and evaluations used. In addition, if circumstances and losses differ substantially from management's assumptions and estimates, the allowance for loan losses may not be sufficient to absorb all future losses and net income could be significantly impacted. 18 LIABILITIES Total liabilities were $7.4 million as of December 31, 2007, and were comprised almost entirely of deposits. In the deposit categories, noninterest bearing DDA deposits were $1.4 million, which was made up primarily of business accounts. NOW accounts, which are owned by individuals, were $0.3 million at December 31, 2007, while money market deposit accounts were $4.4 million and composed primarily of business accounts. Certificates of deposit totaled $1.3 million at December 31, 2007. Of this amount, $0.8 million was in certificates greater than $100,000. All of these certificates are from local depositors.
As of December 31 2007 -------------------- Balance Percentage ------- ---------- Noninterest bearing demand $1,401 18.98% NOW accounts 293 3.97% Money market deposit accounts 4,393 59.50% Savings 4 0.05% Time deposits under $100,000 504 6.83% Time deposits over $100,000 788 10.67% ------ ------ Total deposits $7,383 100.00% ------ ------
Notes payable decreased to zero at December 31, 2007 as the amounts shown on the Company's balance sheet at December 31, 2006 were paid in full and retired with the proceeds of the Company's stock offering. The advances from organizers of $189,990 reflected on the Company's balance sheet at December 31, 2006 were partially refunded to certain organizers, with the balance of $109,990 converted into shares of the Company's stock. SHAREHOLDERS' EQUITY Shareholders' equity increased to $11.9 million at December 31, 2007 from a deficit of ($685,000) at December 31, 2006. During 2007, the Company sold $13.9 million in common stock which was closed in two phases. The first closing with gross proceeds of $12.6 million occurred on February 27, 2007, and the proceeds were used to retire the Company's credit line of $1.8 million and capitalize the Bank at $10.5 million. The remaining $1.3 million of the offering was completed on June 30, 2007 and the closing of these shares occurred in early July, 2007. From these proceeds, $487,000 in deferred offering costs were deducted. Additional paid in capital increased by $686,000 in accordance with FAS123R, as noted in footnote 11 of the financial statements. This represents an offset to the expense recognized per FAS123R of $552,000 for the costs associated with the organizer warrants which were issued to the Company's organizers as described in the prospectus dated August 25, 2006, and $134,000 in shareholder warrants issued in conjunction with the Company's public offering. The accumulated deficit includes a charge for the aforementioned cost. In addition, it includes the costs of inception prior to the Company commencing banking operations of approximately $790,000 incurred during the Company's inception period. NET INTEREST INCOME Net interest income for the twelve months ended December 31, 2007 was $705,000. The Company commenced the earning of interest income at the inception of banking operations on February 28, 2007. During 2007, interest income was provided primarily from federal funds sold as the Company maintained a significant amount of liquidity in its early growth period. Loans were generated beginning in April of 2007 and continued throughout the year which resulted in interest income on loans as shown. Deposit interest expense of $144,000 was due primarily to the growth of money market deposit accounts and certificates of deposit during the period. Interest expense on the Company's line of credit during its organizational phase totaled $22,000. The credit line was paid off and retired with proceeds of the Company's public offering. In 2006, interest expense of $38,000 was recognized on the Company's line of credit used during the Company's inception period. 19 The following table shows the Company's consolidated average balances of assets, liabilities, and equity. The table also details the amount of interest income or interest expense and the average yield or rate for each category of interest earning asset or interest bearing liability and the net interest margin for the period indicated.
Year Ended December 31, 2007 ---------------------------- Interest Average Income/ Average Balance Expense Rate ------- -------- ------- Assets Loans $ 3,480 $269 7.73% Federal funds sold 11,515 594 5.16% Interest bearing deposits with banks 207 8 3.87% ------- ---- ---- Total earning assets/total interest income/average yield 15,202 871 5.73% Cash and due from banks 334 All other assets 1,532 ------- Total assets $17,068 ======= Liabilities and Equity NOW Accounts 191 4 1.98% Money Market Deposit Accounts 2,592 92 3.56% Savings 7 -- .50% Certificates of deposit 1,239 48 3.91% Other 22 ------- ---- ---- Total interest bearing liabilities/total interest Expense/average rate 4,029 166 4.12% Noninterest bearing demand deposits 1,001 All other liabilities 23 Shareholders' equity 12,015 ------- ---- Total liabilities and shareholders' equity $17,068 ======= Net interest income/interest rate spread $705 1.58% ==== ---- Net interest margin (net interest income/total earning assets) 4.64% ----
PROVISION FOR CREDIT LOSSES The provision for loan losses was $88,000 for the year ended December 31, 2007. See also "Assets" discussed previously. NONINTEREST INCOME Noninterest income for 2007 totaled $8,000 and was primarily from service charges and customer service fees. There was no noninterest income earned in prior periods. NONINTEREST EXPENSE Noninterest expense for the twelve months ended December 31, 2007 was $2.04 million. Of this amount, approximately $182,000 was incurred during the inception period between January 1 and February 27, 2007. Salaries and benefits was $758,000 as the Company began hiring the majority of its operating staff during the first quarter of 2007 in anticipation of the commencement of banking operations, to allow for training, and to provide for computer systems and facility setup. Occupancy and equipment expense increased by $104,000 to $167,000 for the twelve months ended December 31, 2007 as compared to $63,000 for the same period ended December 31, 2006. This increase was largely due to the Company's leasing its temporary offices on Grand River Avenue, and due to depreciation and other equipment expenses. Stock based compensation of $552,000 was recognized per FAS123R in 2007. Please see footnote 11 to the financial statements for 20 additional information. Professional fees decreased $257,000 to $158,000 as of December 31, 2007 from $415,000 at December 31, 2006 as the legal and professional fees associated with the Company's organizational phase ended and the Company's executive management team became employees rather than consultants. Advertising and marketing expenses of $101,000 during 2007 were an increase of $79,000 over the same period in 2006 as the Company commenced banking operations. Similarly, increases at December 31, 2007 in data processing, travel and entertainment, printing, dues and memberships, outside office and other expenses were attributable to the Company commencing banking operations. INCOME TAXES No income tax expense or benefit was recognized in 2007 due to the tax loss carryforward position of the Company. See note 9 to the financial statements. An income tax benefit may be recorded in future periods when the Company becomes profitable and management believes that profitability will be expected for the foreseeable future beyond that point. LIQUIDITY AND CAPITAL RESOURCES; ASSET/LIABILITY MANAGEMENT The liquidity of a bank allows it to meet loan requests, to accommodate possible outflows of deposits, and to take advantage of other investment opportunities. Funding of loan requests, providing for liability outflows, and managing interest rate margins requires continuous analysis to attempt to match the maturities and repricing of specific categories of loans and investments with specific types of deposits and other borrowings. Bank liquidity depends upon the mix of the banking institution's potential sources and uses of funds. The major sources of liquidity for the Bank have been deposit growth, federal funds sold, and loans that mature within one year. Large deposit balances which might fluctuate in response to interest rate changes are closely monitored. These deposits consist mainly of money market deposit accounts and certificates of deposit over $100,000. We anticipate that we will have sufficient liquidity to meet our future commitments. As of December 31, 2007, unused commitments comprised $5.2 million. The Bank has $1.2 million in time deposits coming due within the next twelve months from December 31, 2007. The largest uses and sources of cash and cash equivalents for the Company for the year ended December 31, 2007, as noted in the Consolidated Statements of Cash Flow, were centered primarily on the uses of cash in investing activities and the net cash provided by financing activities. The use of cash in investing activities were largely due to the increase in loans of $9.1 million. The purchase of equipment and construction in process of $1.5 million were due predominantly to the ongoing construction costs associated with the Company's headquarters building. Offsetting the use of cash in investing activities was the cash provided from financing activities which included increases in deposits of $7.4 million and the sale of stock of $13.8 million. Repayment of borrowings reduced the cash provided by financing activities by $1.9 million. Total cash and cash equivalents at December 31, 2007 was $7.6 million, which was an increase of $7.6 million from December 31, 2006. Managing rates on earning assets and interest bearing liabilities focuses on maintaining stability in the net interest margin, an important factor in earnings growth and stability. Emphasis is placed on maintaining a controlled rate sensitivity position to avoid wide swings in margins and to manage risk due to changes in interest rates. Some of the major areas of focus of the Company's Asset Liability management Committee ("ALCO") incorporate the following overview functions: review the interest rate sensitivity of the Bank to measure the impact of changing interest rates on the Bank's net interest income, review the liquidity position through various measurements, review current and prospective economic conditions and the corresponding impact on the Bank, ensure that capital and the allowance for loan losses are maintained at proper levels to sustain growth, monitor the investment portfolio, recommend policies and strategies to the Board that incorporate a better balance of our interest rate risk, liquidity, balance sheet mix and yield management, and review the current balance sheet mix and proactively determine the future product mix. The Company currently utilizes a static gap analysis to monitor interest rate risk. The Company expects to implement net interest income simulation modeling to measure and monitor interest rate risk in the latter part of 2008. Due to the short operating history of the Company and its rapidly changing balance sheet as of December 31, 2007, management elected not to implement interest rate simulation as the results it would provide at that point would not have provided meaningful benefits. Each of these interest rate risk measurement models has limitations, but management believes when these tools are evaluated together in the future, they will provide a balanced view of the exposure the Company has to interest rate risk. Interest sensitivity gap analysis measures the difference between the assets and liabilities repricing or maturing within a specific time period. An asset-sensitive position indicates that there are more rate-sensitive assets than rate-sensitive liabilities repricing or maturing at a given point in time, which would generally imply a favorable impact on net interest income in periods of rising interest rates and a negative impact on net interest income in periods of declining interest rates. A liability-sensitive position would generally imply a negative impact on net interest income in periods of rising interest rates and a positive impact in periods of declining interest rates. 21 Gap analysis has limitations because it cannot measure precisely the effect on interest rate movements and competitive pressures on the repricing and maturity characteristics of interest-earning assets and interest-bearing liabilities. In addition, a portion of adjustable-rate assets have limits on their minimum and maximum yield, whereas most of our interest-bearing liabilities are not subject to these limitations. AS a result, certain assets and liabilities indicated as repricing within a stated period may in fact reprice at different times and at different volumes, and certain adjustable-rate assets may reach their yield limits and not reprice. The following table presents an analysis of our interest-sensitivity gap position at December 31, 2007. All interest-earning assets and interest-bearing liabilities are shown based on the earlier of their contractual maturity or repricing date:
After Three After One Within Months but Year but After Three Within Within Five Months One Year Five Years Years Total ------- ----------- ---------- ------- ------- Interest earning assets Federal funds sold $ 4,209 $ -- $ -- $ -- $ 4,209 Interest bearing deposits with banks 3,000 -- -- -- 3,000 Loans 3,587 141 3,359 2,021 9,108 Other -- -- 5 -- 5 ------- ------ ------ ------- ------- Total 10,796 141 3,364 2,021 16,322 ------- ------ ------ ------- ------- Interest bearing liabilities NOW accounts -- -- 293 -- 293 Money market deposit accounts 4,393 -- -- -- 4,393 Savings -- -- 4 -- 4 Time deposits less than $100,000 208 142 155 -- 505 Time deposits greater than $100,000 409 128 150 100 787 ------- ------ ------ ------- ------- Total 5,010 270 602 100 5,982 ------- ------ ------ ------- ------- Rate sensitivity gap $ 5,786 $ (129) $2,762 $ 1,921 ======= ====== ====== ======= Cumulative rate sensitivity gap $5,657 $8,419 $10,340 ====== ====== ======= Rate sensitivity gap ratio 1.87x n/ax 5.59x 20.21x Cumulative rate sensitivity gap ratio 2.07x 2.43x 2.73x
22 ITEM 7. FINANCIAL STATEMENTS REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors Lotus Bancorp, Inc. We have audited the accompanying consolidated balance sheet of Lotus Bancorp, Inc., and subsidiary as of December 31, 2007 and the related consolidated statement of operations, shareholder's equity (deficit) and cash flows for the year ended December 31, 2007. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The consolidated financial statements as of December 31, 2006 and for the year then ended were audited by other auditors whose report dated March 27, 2007 expressed an unqualified opinion. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lotus Bancorp, Inc., and subsidiary as of December 31, 2007 and the results of its operations for the year ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. /s/ Plante & Moran PLLC March 24, 2008 Auburn Hills, MI 23 LOTUS BANCORP, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS ASSETS
December 31 ------------------------ 2007 2006 ----------- ---------- Cash and Cash Equivalents Cash and due from banks $ 356,783 $ 6,422 Interest bearing balances due from banks 3,000,000 -- Federal funds sold 4,209,078 -- ----------- ---------- Total cash and cash equivalents 7,565,861 6,422 Loans, less allowance for loan losses of $88,000 and $0 at December 31, 2007 and 2006, respectively (Note 2) 9,021,152 -- Property and equipment, net of depreciation (Note 5) 2,507,552 1,078,326 Deferred offering costs (Note 1) -- 200,803 Accrued interest receivable and other assets 186,961 113,919 ----------- ---------- Total assets $19,281,526 $1,399,470 =========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY (DEFICIT)
December 31 ------------------------ 2007 2006 ----------- ---------- Deposits (Note 3) Non-interest bearing $ 1,401,162 $ -- Interest bearing 5,981,961 -- ----------- ---------- Total deposits 7,383,123 -- Note payable (Note 6) -- 1,856,775 Advances from organizers (Note 7) -- 189,990 Federal income taxes payable -- 7,700 Accrued interest payable and other liabilities (Note 8) 39,277 30,339 ----------- ---------- Total liabilities 7,422,400 2,084,804 ----------- ---------- Shareholder's equity (Deficit) Common stock, $0.01 par value Authorized -8,000,000 shares Issued and outstanding - 1,389,965 shares at December 31, 2007 and 1 share at December 31, 2006 13,899 -- Additional paid in capital 13,950,787 10 Retained earnings (deficit) (2,105,560) (685,344) ----------- ---------- Total shareholder's equity (deficit) 11,859,126 (685,334) ----------- ---------- Total liabilities and shareholder's equity (deficit) $19,281,526 $1,399,470 =========== ==========
See Notes to Financial Statements 24 LOTUS BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF OPERATIONS
For the Year Ended December 31 ----------------------- 2007 2006 ----------- --------- Interest income: Loans receivable, including fees $ 268,642 $ -- Federal funds sold 594,187 -- Interest bearing deposits with banks 8,017 -- Other 67 89,536 ----------- --------- Total interest income 870,913 89,536 ----------- --------- Interest expense: Deposits 144,499 -- Other 21,675 38,169 ----------- --------- Total interest expense 166,174 38,169 ----------- --------- Net interest income 704,739 51,367 Provision for loan losses 88,000 -- ----------- --------- Net interest income after provision for loan losses 616,739 51,367 Non-interest income Service charges on deposit accounts 5,147 -- Gain on sale of loans 1,180 -- Other income 1,296 -- ----------- --------- Total non-interest income 7,623 -- Non-interest expense Salary and benefits 758,626 -- Occupancy and equipment expense 167,311 63,201 Stock based compensation 552,449 -- Professional fees 157,719 415,300 Advertising and public relations 100,979 21,711 Data processing expenses 66,122 -- Travel and entertainment 50,879 21,405 Printing and office supplies 37,524 8,988 Dues and memberships 31,639 3,020 Outside office services 30,135 26,818 Other expense 91,195 32,720 ----------- --------- Total non-interest expense 2,044,578 593,163 Net loss before taxes (1,420,216) (541,796) Income taxes (Note 6) -- -- ----------- --------- Net loss (1,420,216) (541,796) =========== ========= Basic earnings/(loss) per share (1.23) (541,796) =========== ========= Diluted earnings/(loss) per share (1.23) (541,796) =========== ========= Weighted average shares 1,155,946 1
See Notes to Financial Statements 25 LOTUS BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT STOCKHOLDERS' EQUITY (DEFICIT)
Common Paid in Accumulated Stock Capital Deficit Total ------- ----------- ----------- ----------- Balance January 1, 2005 $ -- $ -- $ -- $ -- Issuance of 1 share of common stock -- 10 -- 10 Net loss -- -- (143,548) (143,548) ------- ----------- ----------- ----------- Balance December 31, 2005 -- 10 (143,548) (143,538) Net loss -- -- (541,796) (541,796) ------- ----------- ----------- ----------- Balance December 31, 2006 -- 10 (685,344) (685,334) Issuance of 1,389,965 shares of common stock 13,899 13,885,741 13,899,640 Deferred offering costs -- (487,413) (487,413) Warrants -- 552,449 552,449 Net loss -- -- (1,420,216) (1,420,216) ------- ----------- ----------- ----------- Balance December 31, 2007 $13,899 $13,950,787 $(2,105,560) $11,859,126 ======= =========== =========== ===========
See Notes to Financial Statements 26 LOTUS BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year Ended December 31 -------------------------- 2007 2006 ------------ ----------- CASH FLOWS FROM OPERATING ACTIVITIES Adjustments to reconcile actual loss to net cash to operating activities Net loss $ (1,420,216) $ (541,796) Warrant expense 552,449 -- Depreciation 96,393 6,625 Provision for loan losses 88,000 -- Increase in other assets (73,510) (81,219) Increase (decrease) in other liabilities 8,938 (17,076) Increase (decrease) in federal income taxes payable (7,700) 7,700 (Increase) decrease in deferred income tax benefit 468 (7,700) ------------ ----------- Net cash used in operating activities (755,178) (633,466) CASH FLOWS FROM INVESTING ACTIVITIES Net increase in loans (9,109,152) -- Purchase of equipment (1,525,619) (1,084,951) ------------ ----------- Net cash used in investing activities (10,634,771) (1,084,951) CASH FLOWS FROM FINANCING ACTIVITIES Increase in deferred offering costs (286,610) (200,803) Increase in non-interest bearing deposits 1,401,162 -- Increase in interest bearing deposits 5,981,961 -- Advances (payments) on line of credit (1,856,775) 1,856,775 Issuance of common stock 13,789,650 -- Decrease in advances from organizers (80,000) -- ------------ ----------- Net cash provided by financing activities 18,949,388 1,655,972 ------------ ----------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 7,559,439 (62,445) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 6,422 68,867 ------------ ----------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 7,565,861 $ 6,422 ============ =========== Supplemental Disclosure of Non-cash Financing Activity: Conversion of advances from organizers into shares of common stock $ 109,990 $ --
See Notes to Financial Statements 27 LOTUS BANCORP, INC. AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES BASIS OF PRESENTATION - The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and with the instructions to Form 10-KSB. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of Lotus Bancorp, Inc. (the "Company"), and its wholly-owned subsidiary, Lotus Bank (the "Bank"). All significant inter-company accounts and transactions have been eliminated. ORGANIZATION - Lotus Bancorp, Inc. (the "Company") was incorporated as De Novo Holdings, Inc. on October 27, 2004 for the purpose of becoming a bank holding company under the Bank Holding Company Act of 1956, as amended. The Company subsequently changed its name to Lotus Bancorp, Inc. The Company received the required regulatory approvals to purchase the common stock of Lotus Bank (the "Bank") on February 2, 2007. The Company withdrew common stock subscription funds totaling $12,582,050 from its escrow account on February 27, 2007 and capitalized the Bank with $10,500,000 on that same date. The Bank commenced operations on February 28, 2007. The Company completed the public offering of its common stock on June 30, 2007. The Company raised a total of $13,899,650 in capital. As of March 24, 2008, there were 1,389,965 shares of common stock issued and outstanding. USE OF ESTIMATES - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates and assumptions. Material estimates that are particularly susceptible to significant change in the near term include the determination of the allowance for loan losses and the valuation of deferred tax assets. CASH AND CASH EQUIVALENTS - Cash and cash equivalents are comprised of highly liquid investments with purchase maturities of three months or less. Cash equivalents are carried at cost, which approximates fair value. At times bank balances may be in excess of insured limits. Management has deemed this a normal business risk. ORGANIZATION AND PRE-OPENING COSTS - Organization and pre-opening costs represent incorporation costs, legal, accounting, consultant and other professional fees and costs relating to the organization. Management anticipated that the organization and pre-opening costs totaled approximately $790,000 through the commencement of operations, and were charged to expense as incurred. DEFERRED OFFERING COSTS - Direct costs relating to the offering of common stock totaled approximately $487,000 through December 31, 2007, and were capitalized and netted against the offering proceeds. LOANS - The Company grants mortgage, commercial and consumer loans to customers. A large portion of the loan portfolio is represented by commercial and commercial real estate loans in Oakland County, Michigan and elsewhere. The ability of the Company's debtors to honor their contracts is dependent upon the real estate and general economic conditions in those areas. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using either the straight line or interest method. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed in nonaccrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. 28 ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Actual loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance consists of specific, general and allocated components. The specific component relates to loans that are classified as either doubtful, substandard, or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash slows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers nonclassified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management's estimates of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the borrower and the loan, including length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable interest rate, or the fair value of the collateral if the loan is collateral dependent. Large groups of homogenous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential mortgage loans for impairment disclosures. During the first three years of operation, the Bank will maintain an allowance for loan losses at or above minimum level of 1.00% established by the Federal Deposit Insurance Corporation and the State of Michigan Office of Financial and Insurance Services pursuant to their orders granting the Bank authority to commence activity as a DeNovo financial institution. OFF-BALANCE-SHEET INSTRUMENTS - In the ordinary course of business, the Company has entered into commitments under commercial lines of credit and standby letters of credit. Such financial instruments are recorded when they are funded. PROPERTY AND EQUIPMENT - Equipment is stated at cost. Depreciation is computed for financial reporting purposes using the straight-line method over the useful life of the assets. INCOME TAXES - Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effect of the various temporary differences between the book value and tax basis of the various balance sheet assets and liabilities, and requires the current recognition of changes in tax rates and laws. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. EARNINGS PER SHARE - Basic earnings per share have been computed by dividing the net loss by the weighted-average number of common shares outstanding for the period. RECLASSIFICATION - Certain amounts appearing in the prior year's financial statements have been reclassified to conform to the current year's financial statements. RECENT ACCOUNTING PRONOUNCEMENTS - in July 2006, the Financial Accounting Standards Board ("FASB") Financial Interpretation No. 48, "Accounting for Uncertainty in Income Taxes," ("FIN 48") which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes." This interpretation provides guidance on the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Further, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosures and transition. The interpretation is effective for fiscal years beginning after 29 December 15, 2006. The Company is not aware of any tax position recognized in the financial statements that is subject to tax law under varied interpretation and which might not be upheld if examined and ruled upon by a taxing authority. In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, "Fair Value Measurements" ("FASB 157"). FASB 157 enhances existing guidance for measuring assets and liabilities using fair value. Prior to the issuance of FASB 157, guidance for applying fair value was incorporated in several accounting pronouncements. FASB 157 provides a single definition of fair value, together with a framework for measuring it, and required additional disclosure about the use of fair value to measure assets and liabilities. FASB 157 also emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active markets. Under FASB 157, fair value measurements are disclosed by level within the hierarchy. While FASB 157 does not add any new fair value measurements, it does change current practice. Changes to practice include: (1) a requirement for an entity to include its own credit standing in the measurement of its liabilities; (2) a modification of the transaction price presumption; (3) a prohibition on the use of block discounts when valuing large blocks of securities for broker dealers and investment companies; and (4) a requirement to adjust the value of restricted stock for the effect of the restriction even if the restriction lapses within one year. FASB 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company has not determined the effect of adopting FASB 157 on its financial statements. In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, :The Fair Value Option for Financial Assets and Liabilities," ("FASB 159"). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. An entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The statement is effective as of the beginning of an entity's first fiscal year that begins after November 15, 2007. The Company is continuing to evaluate the impact of this statement. In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R, "Share Based Payments," ("FASB 123R") which was a revision to Statement No. 123, "Accounting for Stock Based Compensation." This standard required the Company to measure the cost of employee services received in exchange for equity awards, including stock options, based on the grant date fair value of the awards. The cost is recognized as compensation expense over the vesting period of the awards. During the year ended December 31, 2007, the Company issued 277,993 warrants to shareholders to purchase the Company's common stock at an exercise price of $12.50 per share, based upon one warrant for each five shares of stock purchased, for a duration of three years. The Company recognized stock based compensation using the Black-Scholes option-pricing model of $133,715 for the year ended December 31,2007. During the year ended December 31, 2007, the Company also issued 142,500 warrants to purchase the Company's common stock to organizers at an exercise price of $10.00 with a duration of 10 years. The Company recognized stock based compensation expense using the Black-Scholes option-pricing model of $552,449 for the year ended December 31, 2007. The fair value of each warrant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions. The assumptions listed below were used in 2007:
Shareholder Organizer Warrants Warrants ----------- --------- Dividend yield or expected dividends 0.00% 0.00% Risk free interest rate 4.50% 4.65% Expected life 3 yrs. 10 yrs. Expected volatility 12.00% 12.00%
30 NOTE 2 - LOANS A summary of the balances of loans as of December 31, 2007 is as follows. The Company had no loans on its books as of December 31, 2006:
2007 ---------- Mortgage loans on real estate: Residential 1 to 4 family $1,097,735 Commercial 3,238,981 Second mortgage 147,000 Equity lines of credit 363,462 ---------- Total mortgage loans on real estate 4,847,178 Commercial loans 3,441,966 Consumer installment loans 802,756 ---------- Total loans 9,091,900 ---------- Less: Allowance for loan losses 88,000 Net deferred loan fees (17,252) ---------- Net loans $9,021,152 ==========
The following table shows the maturities and sensitivity to changes in interest rates of the loan portfolio as of December 31, 2007:
Maturing or repricing in ------------------------------------ less than 1 to 5 after 1 year years 5 years Total ---------- ---------- ---------- ---------- Commercial and financial $2,566,940 $2,110,443 $2,020,816 $6,698,199 Real estate - mortgage 363,462 827,735 417,000 1,608,197 Installment loans to individuals 380,695 421,407 654 802,756 ---------- ---------- ---------- ---------- Total loans $3,311,097 $3,359,585 $2,438,470 $9,109,152 ========== ========== ========== ==========
At December 31, 2007 loans maturing in greater than 1 year are comprised of the following: Fixed rate $4,695,259 Variable rate $2,493,477
The Corporation has no loan concentrations greater than 10% of total loans. An analysis of the allowance for loan losses follows:
2007 ------- Balance at beginning of year $ 0 Provision for loan losses 88,000 Loans charged off 0 Recoveries on loans previously charged off 0 ------- Balance at end of year $88,000 =======
At December 31, 2007, there were no loans considered to be impaired or over 90 days delinquent and still accruing. In the ordinary course of business, the Bank has granted loans to executive officers and directors and their affiliates amounting to $ 1,855,911at December 31, 2007 and zero at December 31, 2006. During the year ended December 31, 2007, total principal additions were $ 1,902,141and total principal payments were $ 46,130. 31 NOTE 3 - DEPOSITS The following is a summary of the distribution of deposits as of December 31, 2007:
2007 ---------- Noninterest bearing deposits $1,401,162 NOW Accounts 293,119 Savings and money market accounts 4,396,649 Certificates of deposit less than $100,000 504,079 Certificates of deposit greater than $100,000 788,114 ---------- Total $7,383,123 ==========
At December 31, 2007, the scheduled maturities of time deposits are as follows:
Less than Greater than $100,000 $100,000 Total --------- ------------ ---------- 2008 $504,079 $688,114 $1,192,193 2009 -- 100,000 100,000 -------- -------- ---------- Total $504,079 $788,114 $1,292,193 ======== ======== ==========
NOTE 4 - OFF BALANCE SHEET ARRANGEMENTS CREDIT RELATED FINANCIAL INSTRUMENTS - The subsidiary bank is a party to credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit, and undisbursed lines of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The Bank's exposure to credit loss is represented by the contractual amount of these commitments. The Bank follows the same credit policies in making commitments as it does for on-balance sheet instruments. The contractual amounts of commitments to extend credit, standby letters of credit, and undisbursed lines of credit as of December 31, 2007 and December 31, 2006 are shown below:
December 31, 2007 ----------------- Commitments to extend credit $2,373,000 Standby letters of credit 212,214 Undisbursed lines of credit 2,608,965 ---------- Total $5,194,179 ----------
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require repayment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management's credit evaluation of the customer. Undisbursed lines of credit under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit can be collateralized and may not be drawn upon to the total extent to which the Company is committed. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters of credit are used primarily to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved is extending loan facilities to those customers. The Company generally holds collateral supporting those commitments if deemed necessary. COLLATERAL REQUIREMENTS - To reduce credit risk related to the use of credit-related financial instruments, the Company might deem it necessary to obtain collateral. The amount and nature of the collateral obtained are based on the Company's evaluation of the customer. Collateral held varies but may include cash, securities, accounts receivable, inventory, property, plant, and equipment, and real estate. 32 If the counterparty does not have the right and the ability to redeem the collateral or the Company is permitted to sell or repledge the collateral on short notice, the Company records the collateral on its balance sheet at fair value with a corresponding obligation to return it. LEGAL CONTINGENCIES - various legal claims also arise from time to time in the normal course of business which, in the opinion of management, will have no material effect on the Company's financial statements. NOTE 5 - PROPERTY AND EQUIPMENT Property and equipment consist of the following:
December 31, 2007 December 31, 2006 ----------------- ----------------- Construction in Progress $1,276,741 $ 81,258 Land 854,233 854,233 Office Equipment 479,092 149,460 ---------- ---------- 2,610,066 1,084,951 Less: Accumulated depreciation 102,514 6,625 ---------- ---------- Property and equipment net of depreciation $2,507,552 $1,078,326 ---------- ----------
NOTE 6 - NOTE PAYABLE On February 1, 2006, the Company signed a $1,000,000 line of credit agreement with the Bankers Bank of Atlanta, Georgia. The Line was increased to $2,100,000 on August 16, 2006. The line of credit was payable on demand with interest at the prime rate (8.25% as of December 31, 2006) minus one percent, and was secured by the personal guarantees of the Company's Organizers. The guarantee of each organizer was limited to $121,053. The line of credit expired February 28, 2007, and was retired with the proceeds from the Company's initial public offering. NOTE 7 - ADVANCES FROM ORGANIZERS Advances from Organizers in the amount of $189,990 were used for certain operating and pre-opening expenses. Of the advances, $80,000 were refunded to certain of the Company's organizers, and the balance of $109,990 in advances was retired by issuing common stock to the remaining organizers having an aggregate subscription price equal to the amount advanced by those organizers. NOTE 8 - OTHER LIABILITIES In 2006, the Company entered into consulting agreements with five individuals, all of whom became employees of the Bank upon opening. These agreements call for additional payments to be paid to certain of the parties in the amount of $57,500 which was paid to those individuals on February 28, 2007 in satisfaction of the provision contained in the consulting agreements, and was expensed in the Company's financial statements. 33 NOTE 9 - INCOME TAXES The Company has net operating loss carryforwards of approximately $2,105,000 generated from inception through December 31, 2007 that are available to reduce future taxable income through the year ending December 31, 2027. The deferred tax asset generated by that loss carryforward has been offset with a valuation allowance since the Company does not have a history of earnings. The components of the Company's provision for income taxes for the years ended December 31, 2007 and 2006 are as follows:
December 31 --------------------- 2007 2006 --------- --------- Income tax benefit at statutory rate of 34% $ 482,873 $ 184,211 Change in valuation allowance (483,000) (176,000) Other - net 127 (511) --------- --------- Net income tax expense $ -- $ 7,700 --------- ---------
Components of the Company's deferred tax assets at December 31 are summarized as follows:
2007 2006 --------- --------- Deferred tax asset: Net operating loss carryforward $ 685,970 $ 233,017 Allowance for loan losses 29,920 -- Valuation allowance (708,658) (225,317) --------- --------- Net deferred tax asset $ 7,232 $ 7,700 --------- ---------
NOTE 10 - LEASES AND COMMITMENTS On August 10, 2006, the Company entered into a lease agreement for temporary office space, which calls for lease payments of $3,753 per month through September 2, 2007, and $4,314 per month, on a month to month basis thereafter. Rent expense for the years ended December 31, 2007 and December 31, 2006 totaled $49,638 and $11,256, respectively. The following is a schedule of future minimum rental payments under the operating leases on a calendar basis:
Year Ending December 31 Amount ----------------------- ------- 2008 $17,256 ------- Total $17,256 =======
On August 19, 2007, the Company broke ground and commenced construction on its headquarters building located at the intersection of 12Mile and Dixon Roads in Novi. The approximately 5,200 square foot building will feature full-service banking accommodations and will also house the Company's executive management. As of December 31, 2007, the Company has outstanding commitments under construction agreements totaling $2,046,083 for the construction of its headquarters, and has been billed for $1,276,741. NOTE 11 - STOCK OPTIONS AND WARRANTS The Company plans to issue 55,000 stock options to the future executive officers of the Bank upon approval from the Board of Directors. These proposed options and warrants would be issued with a strike price of $10. In conjunction with its completed stock offering, the Company has issued a total of 277,993 warrants to initial shareholders in the ratio of one warrant for every five shares of common stock purchased in the offering. These warrants would have a strike price of $12.50. Additionally, the Company has issued 142,500 warrants to its organizers. These warrants have a strike price of $10.00. A total of 420,493 warrants to purchase the Company's common stock are outstanding. At of December 31, 2006, no warrants were outstanding. Statement of Financial Accounting Standards ("SFAS") No. 123 (Revised) requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors. SFAS No. 123 (R) requires companies to estimate the fair value of the stock-based payment awards on the date of grant using an option-pricing model. 34 The value of the portion of the award that is ultimately expected to vest is recognized as compensation expense over the requisite service periods in the Company's statement of operations. NOTE 12 - INITIAL PUBLIC OFFERING As described in Note 1 (Organization), the Company conducted an initial public offering through June 30, 2007, in which it raised $13,899,650 in capital. These proceeds were netted against related offering costs of approximately $489,000 and organizational expenses of approximately $790,000. These costs have been recognized on the books of the Company. NOTE 13 - SUBSEQUENT EVENTS None. NOTE 14 - MINIMUM REGULATORY CAPITAL REQUIREMENTS Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking authorities. Capital adequacy guidelines and, additionally for the Bank, prompt corrective action regulations, involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting policies. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. The prompt corrective action regulations provide five classifications; well capitalized, adequately capitalized, undercapitalized and critical 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 is required. The Bank and the Company were well capitalized as of December 31, 2007. The Bank's and Company's actual capital amounts and ratios as of December 31, 2007 are represented in the following table (dollars in thousands):
For Capital To Be Well Actual Adequacy Purposes Capitalized --------------- ----------------- -------------- Amount Ratio Amount Ratio Amount Ratio ------- ----- ------ ----- ------ ----- As of December 31, 2007: Total Risk Based Capital To Risk Based Assets Lotus Bank $ 9,776 63.42% $1,233 8.00% $1,541 10.00% Lotus Bancorp, Inc. 11,947 77.45% 1,234 8.00% 1,542 10.00% Tier One Capital to Risk Weighted Assets Lotus Bank $ 9,688 62.85% 617 4.00% 925 6.00% Lotus Bancorp, Inc. 11,859 76.88% 617 4.00% 925 6.00% Tier One Capital to Total Assets Lotus Bank $ 9,688 50.27% 771 4.00% 964 5.00% Lotus Bancorp, Inc. 11,859 61.50% 771 4.00% 964 5.00%
NOTE 15 - RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES Banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Company. Prior approval of the Bank's federal regulator is required if the total dividends declared by the Bank in a calendar year exceed the sum of the net profits of the Bank for the preceding three years, less any required transfers to surplus. In addition, dividends paid by the Bank would be prohibited if the effect thereof would cause the Bank's capital to be reduced below applicable minimum standards. Because of the Bank's denovo status and its startup losses, at December 31, 2007, the Bank's retained earnings available for the payment of dividends, without approval from regulators, was $0. Accordingly, all of the Company's investment in the Bank was restricted at December 31, 2007. Loans or advances made by the Bank to the Company are generally limited to 10 percent of the Bank's capital and surplus. Accordingly, at December 31, 2007, Bank funds available for loans or advances to the Company amounted to $1.05 million. 35 The Federal Reserve Bank of Chicago, which is the Company's regulator, however, has restricted borrowings by the Company during its first three years of operation without its prior approval. NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments: CASH AND CASH EQUIVALENTS - the carrying amounts of cash and cash equivalents approximate fair value. LOANS RECEIVABLE - for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values of nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. DEPOSIT LIABILITIES - the fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (i.e. their carrying amounts). The carrying amounts also approximate the fair value for money market deposit, other savings, and variable rate certificate of deposit accounts. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of deposit to a schedule of aggregated expected monthly maturities on time deposits. ACCRUED INTEREST - the carrying amounts of accrued interest approximate fair value. OTHER FINANCIAL INSTRUMENTS - the fair value of other financial instruments, including loan commitments, unfunded lines of credit and unfunded standby letter of credit, based on discounted cash flow analyses, is not material. The carrying and fair values of the Company's assets and liabilities are as follows:
Carrying Fair Value Value ----------- ----------- Cash and due from banks $ 356,783 $ 356,783 Interest bearing deposits with banks 3,000,000 3,000,000 Federal funds sold 4,209,078 4,209,078 Loans - net 9,021,152 9,176,391 Accrued interest receivable 41,709 41,709 Noninterest bearing deposits 1,401,162 1,401,162 Interest bearing deposits 4,689,768 4,689,768 Time deposits 1,292,193 1,296,450 Accrued interest payable 16,879 16,879 Shareholders' equity 11,859,126 11,859,126
36 NOTE 17 - PARENT ONLY FINANCIAL STATEMENTS The condensed financial information that follows presents the financial condition of Lotus Bancorp, Inc. (the "Parent") along with results of operations and its cash flows. The Parent has recorded its investments in its subsidiary at cost plus its share of the undistributed earnings of its subsidiary since inception. The Parent recognizes dividends from its subsidiary as revenue and undistributed earnings of its subsidiary as other income. The Parent financial information should be read in conjunction with the Company's consolidated financial statements. The condensed balance sheet as of December 31, 2007 and December 31, 2006 is as follows: ASSETS
December 31 ------------------------ 2007 2006 ----------- ---------- Cash and Cash Equivalents Cash $ 2,160,222 $ 6,422 ----------- ---------- Total cash and cash equivalents 2,160,222 6,422 Investment in subsidiary 9,688,172 -- Property and equipment, net of depreciation -- 1,078,326 Other assets 10,732 314,722 ----------- ---------- Total assets $11,859,126 $1,399,470 =========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY (DEFICIT)
December 31 ------------------------ 2007 2006 ----------- ---------- Bank note payable -- 1,856,775 Advances from organizers -- 189,990 Other liabilities -- 38,039 ----------- ---------- Total liabilities -- 2,084,804 ----------- ---------- Shareholder's equity (Deficit) Common stock, 13,899 -- Additional paid in capital 13,950,787 10 Retained earnings (deficit) (2,105,560) (685,344) ----------- ---------- Total shareholder's equity (deficit) 11,859,126 (685,334) ----------- ---------- Total liabilities and shareholder's equity (deficit) $11,859,126 $1,399,470 =========== ==========
37 The condensed statement of income for the years ended December 31, 2007 and 2006 is as follows:
Year Ended December 31 ----------------------- 2007 2006 ----------- --------- Interest income $ 168,417 $ 89,536 Interest expense 21,675 38,169 ----------- --------- Net interest income 146,742 51,367 Non-interest expense Occupancy 11,694 63,201 Stock based compensation 552,449 -- Professional fees 152,828 415,300 Other expense 38,159 114,662 ----------- --------- Total non-interest expense 755,130 593,163 Income taxes -- -- ----------- --------- Net income (loss) before equity in undistributed loss of subsidiary (608,388) (541,796) Equity in undistributed loss of subsidiary (811,828) -- ----------- --------- Net loss (1,420,216) (541,796) =========== =========
38 The condensed statement of cash flows for the year ended December 31, 2007 and 2006 is as follows:
For the Year Ended December 31 -------------------------- 2007 2006 ------------ ----------- CASH FLOWS FROM OPERATING ACTIVITIES Adjustments to reconcile actual loss to net cash to operating activities Net loss $ (1,420,216) $ (541,796) Warrant expense 552,449 -- Depreciation -- 6,625 Equity in undistributed loss of subsidiary 811,828 -- (Increase) decrease in other assets 95,487 (81,219) Increase (decrease) in other liabilities (30,339) (17,076) ------------ ----------- Net cash provided by (used in) operating activities 9,209 (633,466) CASH FLOWS FROM INVESTING ACTIVITIES (Purchase) transfer of equipment 1,078,326 (1,084,951) Investment in subsidiary (10,500,000) -- ------------ ----------- Net cash used in investing activities (9,421,674) (1,084,951) CASH FLOWS FROM FINANCING ACTIVITIES Increase in deferred offering costs (286,610) (200,803) Advances (payments) on line of credit (1,856,775) 1,856,775 Issuance of common stock and warrants 13,789,650 -- Decrease in advances from organizers (80,000) -- ------------ ----------- Net cash provided by financing activities 11,566,265 1,655,972 ------------ ----------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,153,800 (62,445) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 6,422 68,867 ------------ ----------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 2,160,222 $ 6,422 ============ =========== Supplemental Disclosure of Non-cash Financing Activity: Conversion of advances from organizers into shares of common stock $ 109,990 $ --
39 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 8A(T). CONTROLS AND PROCEDURES The management of Lotus Bancorp, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. The company's internal control over financial reporting is a process designed under the supervision of the company's chief executive officer and chief financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the company's financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles. Lotus Bancorp, Inc.'s management assessed the effectiveness of the company's internal control over financial reporting as of December 31, 2007 based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in "Internal Control - Integrated Framework." Based on that assessment, management determined that, as of December 31, 2007, the company's internal control over financial reporting is effective, based on those criteria. Management's assessment of the effectiveness of the company's internal control over financial reporting as of December 31, 2007 has been audited by Plante & Moran, PLLC, an independent registered public accounting firm, as stated in their report appearing on page 24. There was no change in the company's internal control over financial reporting that occurred during the company's fiscal quarter ended December 31, 2007, that materially affected, or is reasonably likely to affect, the company's internal control over financial reporting. This annual report does not include an attestation report of the company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the company's registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management's report in this annual report. ITEM 8B. OTHER INFORMATION None. 40 PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE GOVERNANCE, COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT. ROLE AND COMPOSITION OF THE BOARD OF DIRECTORS The Company's Board of Directors is the ultimate decision making body of the Company, except for matters which law or our Articles of Incorporation requires the vote of shareholders. The Board of Directors selects the management of the Company which is responsible for the Company's day to day operations. The Board acts as an advisor to management and also monitors its performance. Certain members of the Company's Board of Directors also serve as Directors of Lotus Bank (the "Bank"), as listed in the chart below. The Bank is the Company's wholly owned subsidiary. During 2007, the Company's Board of Directors had five meetings. In addition, the Company's Board of Directors has authorized four Committees to manage distinct matters of the Company and/or the Bank. These Committees are the Audit Committee, the Loan Committee, the Asset/Liability Management Committee and the Human Resources Committee. Membership on each of the Committees is set forth in the table below. All of the Company's Directors attended 75 percent or more of the meetings of the Board and the Board Committees on which they served in 2007, except for Amarnath Gowda, Murali Guthikonda, Lynn Jerath, Haranath Policherla, Jay Shah and Venkat Talasila.
DIRECTOR DIRECTOR ASSET/ OF THE OF THE LIABILITY HUMAN NAME COMPANY BANK AUDIT LOAN MANAGEMENT RESOURCES ---- -------- -------- ----- ---- ---------- --------- Sreenivas Cherukuri X X X X X Vasudev Garlapaty X Vinaya Gavini X X X X Amarnath Gowda X Ravindranath Gullapalli X X X(1) X X Sarada Gullapalli X Murali Guthikonda X Satish B. Jasti X X X X X Sree Jasti X Lynn Jerath X Mayur Joshi X X X X Shubha Kolachalam X V.S. Lingham X Krishna M. Malempati X Natvarlal Patel X X X X Jitendra Patel X X X X X Haranath Policherla X Bala Setty X X X X Jay Shah X X X X Curt Shaneour X X X X Venkat Talasila X Total Meetings in 2007 5 12 1 6 3 4
---------- (1) Advisory member Currently, the Board of Directors has 21 members divided into three classes of seven directors per class. Each of the three classes of directors is appointed to serve a different three-year term. One class of directors will be up for election each year. This results in a staggered Board which ensures continuity from year to year. 41 CLASS I - DIRECTORS WHOS TERMS EXPIRE IN 2008
POSITION, PRINCIPAL OCCUPATION, NAME AND AGE BUSINESS EXPERIENCE AND DIRECTORSHIP ------------ ---------------------------------------------------- Sreenivas Cherukuri (38) Director since 2006; management consultant, RRA Inc. V.S. Lingham (53) Director since 2006; Chief of Clinical Affairs, Reuther Psychiatric Hospital Satish B. Jasti (48) Director since 2006, President & CEO of the Company and the Bank, formerly a Senior commercial lending officer with Key Bank N.A., LaSalle Bank Midwest N.A., and Bank One N.A. Jitendra Patel (63) Director since 2006; President, Michigan Inns, Inc., real estate investor; retired director, State Bank of Texas Natvarlal Patel (49) Director since 2006; President ECOM Consultants, Inc., technology consultant Jay Shah (61) Director since 2006; CEO, Spalding DeDecker Associates, engineering consulting Curt Shaneour (75) Director since 2006; President, Shane Group Inc.; retired director, Hillsdale County National Bank
CLASS II -- DIRECTORS WHOSE TERMS WILL EXPIRE IN 2009
POSITION, PRINCIPAL OCCUPATION, NAME AND AGE BUSINESS EXPERIENCE AND DIRECTORSHIP ------------ ---------------------------------------------------- Vinaya Gavini (61) Director since 2006; physician; owner Laser Printing Services Amarnath Gowda (54) Director since 2006; attorney Sarada Gullapalli (59) Director since 2006; technical advisor, management consultant, Gullapalli Consulting Services LLC Murali Guthikonda (57) Director since 2006; physician Krishna M. Malempati (65) Director since 2007; Vice President, Om Ventures, Inc. Haranath Policherla (50) Director since 2006; physician
CLASS III -- DIRECTORS WHOSE TERMS WILL EXPIRE IN 2010
POSITION, PRINCIPAL OCCUPATION, NAME AND AGE BUSINESS EXPERIENCE AND DIRECTORSHIP ------------ ---------------------------------------------------- Vasudev Garlapaty (63) Director since 2006; physician Sree Jasti (45) Director since 2006; currently, homemaker; former research scientist with BASF Corp. Lynn Jerath (34) Director since 2006; President, Bedrock Investments LLC Mayur Joshi (54) Director since 2006; Realtor, Max Broock Realtors; real estate investor Shubha Kolachalam (46) Director since 2006; Chief Administrative Officer, Kolachalam MDPC Bala Setty (59) Director since 2006; physician Venkat Talasila (56) Director since 2006; physician; CEO, Sree Talasila Properties LLC
42 FAMILY RELATIONSHIPS Director Sarada Gullapalli is the wife of Director Ravindranath Gullapalli. Director Sree Jasti is the wife of Director, President and Chief Executive Officer Satish B. Jasti. Director Jitendra Patel is the father of Director Lynn Jerath. BACKGROUNDS OF OUR OTHER EXECUTIVE OFFICERS In addition to the information about our Chief Executive Officer, Satish B. Jasti, which is set forth above, the following is information about the Company's other executive officers: Richard E. Bauer, Age 48, Executive Vice President, Chief Financial Officer and Chief Operations Officer of Lotus Bancorp and Lotus Bank. Mr. Bauer has over two decades of experience in the financial services industry. For the twenty-two years prior to joining the Company, he had been with Fidelity Bank, a full service community bank based in Birmingham, Michigan, where he most recently served as Senior Vice President of Operations. He began his banking career with the Detroit Branch of the Federal Reserve Bank of Chicago. Christer D. Lucander, Age 50, Executive Vice President of Lotus Bancorp and Executive Vice President and Chief Lending Officer of Lotus Bank. The Bank hired Mr. Lucander on February 11, 2008. Mr. Lucander has over two decades of experience in the financial services industry. Prior to joining the Company, he had been self-employed as a consultant with a proposed denovo institution by assisting it in obtaining its required regulatory approvals, formulating its business plan, and raising its equity capital. For the twenty-two years prior to that, Mr. Lucander had been with J.P. Morgan Chase Bank, NA and its various predecessor institutions in Detroit, Michigan where he held senior positions in commercial lending, credit administration, loan review and loan operations. AUDIT COMMITTEE The Audit Committee is responsible for the annual appointment of the public accounting firm to be our outside auditors. The Committee is also responsible for the following tasks: - maintaining a liaison with the outside auditors; - reviewing the adequacy of internal controls; - reviewing with management and outside auditors financial disclosures of the Company; and - reviewing any material changes in accounting principles or practices used in preparing statements. AUDIT COMMITTEE FINANCIAL EXPERT While the Board of Directors endorses the effectiveness of the Company's Audit Committee, its membership does not include a director who qualifies for designation as an "audit committee financial expert" - a concept under federal regulation that contemplates such designation only when an audit committee member satisfies all five qualification requirements, such as experience (or "experience actively supervising" others engaged in) preparing, auditing, analyzing or evaluating financial statements presenting a level of accounting complexity comparable to what is encountered in connection with our Company's financial statements. CODE OF ETHICS The Company has adopted a Code of Ethics that applies to all of our employees, officers and directors, including our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. Our Code of Ethics contains written standards that we believe are reasonably designed to deter wrongdoing and to promote: - Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; - Full, fair, accurate, timely, and understandable disclosure in reports and documents that we file with, or submit to, the Securities and Exchange Commissions and in other public communications we make; - Compliance with applicable governmental laws, rules and regulations; 43 - The prompt internal reporting of violations of the code to an appropriate person or persons named in the code; and - Accountability for adherence to the code. This Code of Ethics is included as Exhibit 14 to our Annual Report on Form 10-KSB. We will provide to any person without charge, upon request, a copy of our Code of Ethics. Requests for a copy of our Code of Ethics should be made to our Secretary at 45650 Grand River Avenue, Novi, Michigan 48374. COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT The directors, officers, and 10% or more shareholders of the Company are not presently subject to Section 16(a) of the Exchange Act because the company does not have a class of securities registered under Section 12 of that Act. ITEM 10. EXECUTIVE COMPENSATION The following table shows, for the year ended December 31, 2007, the cash compensation paid by the Company, as well as certain other compensation paid or accrued for the year, to the Chief Executive Officer, Chief Financial Officer and other executive officers ("Named Executive Officers") who accrued compensation in excess of $100,000 in fiscal year 2007. SUMMARY COMPENSATION TABLE ($)
NONQUALIFIED DEFERRED STOCK OPTION COMPENSATION ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS AWARDS AWARDS EARNINGS COMPENSATION TOTAL --------------------------- ---- -------- ----- ------ ------ ------------ ------------ -------- Satish B. Jasti President and CEO 2007 $140,000 -- -- -- -- $22,206(1) $162,206 Richard E. Bauer EVP and CFO 2007 $110,000 -- -- -- -- $ 180(2) $110,180 Richard S. Gurne (3) EVP and Chief Lending Officer 2007 $105,000 -- -- -- -- $ 276(4) $105,276
---------- (1) Includes $14,526 for country club dues, $7,500 for an automobile allowance and $180 for life insurance premium. (2) Represents life insurance premium paid by the Company. (3) Mr. Gurne's employment with the Company terminated on February 7, 2008. (4) Represents life insurance premium paid by the Company. EMPLOYMENT AGREEMENTS Satish B. Jasti. We have entered into an employment agreement with Satish B. Jasti regarding his employment as President and Chief Executive Officer of Lotus Bancorp, Inc. and Lotus Bank. The agreement commenced when the Bank opened for business on February 28, 2007 and continues in effect for three years (with certain exceptions). Thereafter, the agreement will renew automatically unless either party elects to terminate the agreement by sending prior notice to the other party. Under the terms of the agreement, Mr. Jasti receives a base salary of $140,000 per year. Following the first year of the agreement, the base salary will be reviewed by the Bank's board of directors and may be increased as a result of that review. Mr. Jasti is eligible to participate in any executive incentive bonus plan and all other benefit programs that the Bank has adopted. Mr. Jasti also receives other customary benefits such as health, dental and life insurance, membership fees to banking and professional organizations and a monthly automobile allowance of not less than $750. In addition, the Bank provides Mr. Jasti with term life insurance coverage for a term of not less than 10 years, as well as country club and business club membership fees up to $600 per month. Mr. Jasti's employment agreement also provides that we will grant him options to acquire the greater of 3% of the number of shares sold in the initial public offering or 33,000 shares at an exercise price of $10.00 per share, exercisable within ten (10) years from the date of grant of the options. To the maximum extent permitted by law, it is expected that these options will be incentive stock options and would vest ratably over a period of three years beginning on the first anniversary of the date that the Bank opens for business. 44 In the event that Mr. Jasti is terminated, or elects to terminate his employment, in connection with a "change of control," Mr. Jasti would be entitled to receive a cash lump-sum payment equal to 199% of his "base amount" as defined in section 280G of the Internal Revenue Code and, in general, means the executive's annualized compensation over the prior five-year period. If Mr. Jasti's employment is terminated for any reason other than for cause, the Bank will be obligated to pay as severance, an amount equal to one year's base salary. The agreement also provides non-competition and non-solicitation provisions that would apply for a period of one year following the termination of Mr. Jasti's employment. If the Company chooses to enforce the noncompetition provisions, Mr. Jasti will be entitled to a payment of $140,000 or his current salary, whichever is greater. Richard E. Bauer. We have entered into an employment agreement with Richard E. Bauer regarding his employment as Executive Vice President, Chief Financial Officer and Chief Operations Officer of Lotus Bancorp, Inc. and Lotus Bank. The agreement commenced when the Bank opened for business on February 28, 2007 and continues in effect for three years (with certain exceptions). Thereafter, the agreement will renew automatically unless either party elects to terminate the agreement by sending prior notice to the other party. Under the terms of the agreement, Mr. Bauer receives a base salary of $110,000 per year. Following the first year of the agreement, the base salary will be reviewed by the Bank's board of directors and may be increased as a result of that review. Mr. Bauer is eligible to participate in any executive incentive bonus plan and all other benefit programs that the Bank has adopted. Mr. Bauer also receives other customary benefits such as health, dental and life insurance, membership fees to banking and professional organizations. Mr. Bauer's employment agreement also provides that we will grant him options to acquire the greater of 1% of the number of shares sold in the initial public offering or 11,000 shares at an exercise price of $10.00 per share, exercisable within ten (10) years from the date of grant of the options. To the maximum extent permitted by law, it is expected that these options will be incentive stock options and would vest ratably over a period of three years beginning on the first anniversary of the date that the Bank opens for business. In the event that Mr. Bauer is terminated, or elects to terminate his employment, in connection with a "change of control," Mr. Bauer would be entitled to receive a cash lump-sum payment equal to 125% of his "base amount" as defined in section 280G of the Internal Revenue Code and, in general, means the executive's annualized compensation over the prior five-year period. If Mr. Bauer's employment is terminated for any reason other than for cause, the Bank will be obligated to pay as severance, an amount equal to half of one year's base salary. The agreement also provides non-competition and non-solicitation provisions that would apply for a period of one year following the termination of Mr. Bauer's employment. If the Company chooses to enforce the noncompetition provisions, Mr. Bauer will be entitled to a payment of $55,000 or half his current salary, whichever is greater. Christer D. Lucander. We have entered into an employment agreement with Christer D. Lucander regarding his employment as Executive Vice President and Chief Lending Officer of Lotus Bancorp, Inc. and Lotus Bank. The agreement commenced on February 11, 2008 and continues in effect until February 28, 2010 (with certain exceptions). Thereafter, the agreement will renew automatically unless either party elects to terminate the agreement by sending prior notice to the other party. Under the terms of the agreement, Mr. Lucander receives a base salary of $115,000 per year. Following the first year of the agreement, the base salary will be reviewed by the Bank's board of directors and may be increased as a result of that review. Mr. Lucander is eligible to participate in any executive incentive bonus plan and all other benefit programs that the Bank has adopted. Mr. Lucander also receives other customary benefits such as health, dental and life insurance. Mr. Lucander's employment agreement also provides that we will grant him options to acquire the one-quarter of 1% of the number of shares sold in the initial public offering at an exercise price of $10.00 per share, exercisable within ten years from the date of grant of the options. In the event that Mr. Lucander is terminated, or elects to terminate his employment, in connection with a "change of control," Mr. Lucander would be entitled to receive a cash lump-sum payment equal to 125% of his then current salary or $143,750, whichever is greater. If Mr. Lucander's employment is terminated for any reason other than for cause, the Bank will be obligated to pay as severance, an amount equal to half of one year's then current salary or $57,500, whichever is greater. 45 The agreement also provides non-competition and non-solicitation provisions that would apply for a period of six months following the termination of Mr. Lucander's employment. If the Company chooses to enforce the noncompetition provisions, Mr. Lucander will be entitled to a payment equal to half of one year's then current salary or $57,500, whichever is greater. OPTION GRANTS IN 2007 The following table sets forth certain information concerning the number and value of stock options granted in the last fiscal year to the individuals named above in the summary compensation table: 2007 GRANTS OF PLAN-BASED AWARDS TABLE
ALL OTHER ALL OTHER STOCK AWARDS: OPTION AWARDS: NUMBER OF NUMBER OF EXERCISE OR GRANT DATE SHARES OF SECURITIES BASE PRICE FAIR VALUE STOCK OR UNDERLYING OF OPTION OF OPTION GRANT UNITS OPTIONS AWARDS AWARDS NAME DATE (#) (#) ($/SH) ($) ---- ----- ------------- -------------- ----------- ---------- Satish B. Jasti N.A. N.A. N.A. N.A. N.A. Richard E. Bauer N.A. N.A. N.A. N.A. N.A. Richard S. Gurne N.A. N.A. N.A. N.A. N.A.
---------- (1) The Company intends to issue 41,699 and 13,900 options to Messrs. Jasti and Bauer, respectively, at an exercise price of $10.00 per share, subject to the approval by the Company's shareholders of the Company's Stock Incentive Plan at the Company's 2008 Annual Meeting of Shareholders. The options are anticipated to vest ratably (1/3rd per year) over a three-year period beginning 2/28/2008 (the one-year anniversary of the Bank's opening). If the Stock Incentive Plan is approved as proposed, the options will expire on 2/28/2017. 2007 OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END TABLE
OPTION AWARDS ---------------------------------------------------------------------- NUMBER OF NUMBER OF SECURITIES SECURITIES UNDERLYING UNDERLYING UNEXERCISED UNEXERCISED OPTION OPTIONS OPTIONS EXERCISE OPTION (#) (#) PRICE EXPIRATION NAME EXERCISABLE UNEXERCISABLE ($) DATE ---- ----------- ------------- -------- ---------- Satish B. Jasti N.A. N.A. N.A. N.A. Richard E. Bauer N.A. N.A. N.A. N.A. Richard S. Gurne N.A. N.A. N.A. N.A.
---------- (1) The Company intends to issue 41,699 and 13,900 options to Messrs. Jasti and Bauer, respectively, at an exercise price of $10.00 per share, subject to the approval by the Company's shareholders of the Company's Stock Incentive Plan at the Company's 2008 Annual Meeting of Shareholders. The options are anticipated to vest ratably (1/3rd per year) over a three-year period beginning 2/28/2008 (the one-year anniversary of the Bank's opening). If the Stock Incentive Plan is approved as proposed, the options will expire on 2/28/2017. 46 2007 DIRECTOR COMPENSATION TABLE
NONQUALIFIED DEFERRED FEES EARNED OR STOCK OPTION COMPENSATION ALL OTHER PAID IN CASH AWARDS AWARDS EARNINGS COMPENSATION TOTAL NAME ($) ($) ($) ($) ($) ($) ---- -------------- ------ ------ ------------ ------------ ----- Sreenivas Cherukuri $0 $0 $0 $0 $0 $0 Vasudev Garlapaty $0 $0 $0 $0 $0 $0 Vinaya Gavini $0 $0 $0 $0 $0 $0 Amarnath Gowda $0 $0 $0 $0 $0 $0 Ravindranath Gullapalli $0 $0 $0 $0 $0 $0 Sarada Gullapalli $0 $0 $0 $0 $0 $0 Murali Guthikonda $0 $0 $0 $0 $0 $0 Satish B. Jasti $0 $0 $0 $0 $0 $0 Sree Jasti $0 $0 $0 $0 $0 $0 Lynn Jerath $0 $0 $0 $0 $0 $0 Mayur Joshi $0 $0 $0 $0 $0 $0 Shubha Kolachalam $0 $0 $0 $0 $0 $0 V.S. Lingham $0 $0 $0 $0 $0 $0 Krishna M. Malempati $0 $0 $0 $0 $0 $0 Natvarlal Patel $0 $0 $0 $0 $0 $0 Jitendra Patel $0 $0 $0 $0 $0 $0 Haranath Policherla $0 $0 $0 $0 $0 $0 Bala Setty $0 $0 $0 $0 $0 $0 Jay Shah $0 $0 $0 $0 $0 $0 Curt Shaneour $0 $0 $0 $0 $0 $0 Venkat Talasila $0 $0 $0 $0 $0 $0
47 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS SECURITY OWNERSHIP OF DIRECTORS AND EXECUTIVE OFFICERS, ALL DIRECTORS AND EXECUTIVE OFFICERS AS A GROUP AND FIVE PERCENT SHAREHOLDERS Pursuant to rules promulgated by the Securities and Exchange Commission ("SEC") under the Exchange Act, a person or entity is considered to beneficially own shares of Common Stock if the person or entity has or shares (i) voting power, which includes the power to vote or to direct the voting of the shares, or (ii) investment power, which includes the power to dispose or direct the disposition of the shares. Unless otherwise indicated, a person has sole voting power and sole investment power with respect to the indicated shares.
AMOUNT AND NAME OF NATURE OF BENEFICIAL OWNERSHIP AS A DIRECTOR OR EXECUTIVE OFFICER OWNERSHIP PERCENT OF CLASS(1) ----------------------------- -------------------- ------------------- Richard E. Bauer 15,000(2) 1.08% Sreenivas Cherukuri 22,500(3) 1.61% Vasudev Garlapaty 23,100(4) 1.65% Vinaya Gavini 97,500(5) 6.95% Amarnath Gowda 19,500(6) 1.40% Ravindranath Gullapalli 11,200(7) 0.81% Sarada Gullapalli 20,280(8) 1.46% Richard S. Gurne 8,160(9) 0.59% Murali Guthikonda 12,500(10) 0.89% Satish B. Jasti 37,500(11) 2.67% Sree Jasti 9,000(12) 0.65% Lynn Jerath 19,500(13) 1.39% Mayur Joshi 40,740(14) 2.90% Shubha Kolachalam 25,500(15) 1.82% V.S. Lingham 31,500(16) 2.25% Krishna M. Malempati 9,600(17) 0.69% Natvarlal Patel 37,500(18) 2.67% Jitendra Patel 140,700(19) 9.91% Haranath Policherla 25,500(20) 1.82% Bala Setty 19,500(21) 1.39% Jay Shah 23,100(22) 1.65% Curt Shaneour 19,500(23) 1.39% Venkat Talasila 26,820(24) 1.91% All directors and executive officers as a group (23 persons) 695,700 38.43% Shareholders Beneficially Holding Five Percent (5%) or More (other than the directors and executive officers) NONE
---------- (1) Based on 1,389,965 shares of common stock issued and outstanding as of March 24, 2008. (2) Includes 12,500 shares of common stock and warrants to purchase up to 2,500 shares of common stock, all held by the Richard E. Bauer IRA. (3) Includes 12,500 shares of common stock and warrants to purchase up to 10,000 shares of common stock, all held The Cherukuri Family LLC. (4) Includes warrants to purchase up to 10,100 shares of common stock. (5) Includes warrants to purchase up to 20,000 shares of common stock held by Mr. Gavini, individually, and includes 12,500 shares of common stock and warrants to purchase up to 2,500 shares of common stock, all held by Mr. Gavini's wife. (6) Includes warrants to purchase up to 9,500 shares of common stock. (7) Includes 3,100 shares of common stock and warrants to purchase up to 620 shares of common stock, all held by the Ravindranath Gullapalli IRA, and includes warrants to purchase up to 7,500 shares of common stock held jointly with Mr. Gullapalli's wife, Sarada Gullapalli. (8) Includes 16,900 shares of common stock and warrants to purchase up to 3,380 shares of common stock, all held by the Sarada Gullapalli IRA. Ravindranath Gullapalli is Ms. Gullapalli's husband. (9) Includes 6,800 shares of common stock and warrants to purchase up to 1,360 shares of common stock, all held by the Richard S. Gurne IRA. 48 (10) Includes 10,000 shares of common stock and warrants to purchase up to 9,500 shares of common stock, all held by the Murali Guthikonda IRA, and includes 2,500 shares of commons tock and warrants to purchase up to 500 shares of common stock, all held by Mr. Guthikonda's wife. (11) Includes 25,000 shares of common stock and warrants to purchase up to 5,000 shares of common stock, all held by the Satish B. Jasti IRA, and includes warrants to purchase up to 7,500 shares of common stock held jointly with Mr. Jasti's wife, Sree Jasti. (12) Includes 7,500 shares of common stock and warrants to purchase up to 1,500 shares of common stock, all held by the Sree Jasti IRA. Satish Jasti is Ms. Jasti's husband. (13) Includes warrants to purchase up to 9,500 shares of common stock. (14) Includes 22,000 shares of common stock and warrants to purchase up to 11,900 shares of common stock, all held jointly with Mr. Joshi's wife, and includes 5,700 shares of common stock and warrants to purchase up to 1,140 shares of common stock, all held by the Chandrika Joshi IRA (15) Includes warrants to purchase up to 10,500 shares of common stock. (16) Includes warrants to purchase up to 11,500 shares of common stock. (17) Includes warrants to purchase up to 400 shares of common stock held by Mr. Malempati, individually, and includes 6,000 shares of common stock and warrants to purchase up to 1,200 shares of common stock, all held by Mr. Malempati's wife. (18) Includes 25,000 shares of common stock and warrants to purchase up to 12,500 shares of common stock, all held by the Natvarlal Patel IRA. (19) Includes 101,000 shares of common stock and warrants to purchase up to 27,700 shares of common stock, all held by the Jitendra Patel Revocable Living Trust, and includes 10,000 shares of common stock and warrants to purchase up to 2,000 shares of common stock, all held by the Anita Patel Revocable Living Trust. Anita Patel is Mr. Patel's wife. (20) Includes 15,000 shares of common stock and warrants to purchase up to 10,500 shares of common stock, all held by Neuro Rehab Services PC Profit Sharing Plan. (21) Includes warrants to purchase up to 9,500 shares of common stock. (22) Includes 13,000 shares of common stock and warrants to purchase up to 10,100 shares of common stock, all held by the Jayprakash B. Shah IRA. (23) Includes 10,000 shares of common stock and warrants to purchase up to 9,500 shares of common stock, all held by The Shane Group, Inc. (24) Includes warrants to purchase up to 10,500 shares of common stock held by Mr. Talasila, individually, and includes 1,100 shares of common stock and warrants to purchase up to 220 shares of common stock, all held by Mr. Talasila's wife. EQUITY COMPENSATION PLANS The Company has not adopted any equity compensation plans. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE. The Bank makes loans to directors and executive officers from time-to-time in the ordinary course of business. The Bank's current policy provides that: - In the case of banking transactions, each transaction will be on substantially the same terms, including price or interest rate and collateral, as those prevailing at the time for comparable transactions with unrelated parties, and any banking transactions will not be expected to involve more than the normal risk of collectibility or present other unfavorable features to us; - In the case of business transactions, each transaction will be on terms no less favorable than could be obtained from an unrelated third party; and - In the case of all related party transactions, each transaction will be approved by a majority of the directors, including a majority of the directors who do not have an interest in the transaction. In 2007, the Company did not engage or enter into any business transactions with persons related to the Company.. Our Board of Directors has determined that each of our directors, with the exception of Satish B. Jasti, as President and Chief Executive Officer of the Company, are independent as independence is defined in the NASDAQ's listing standards, as those standards have been modified or supplemented. 49 ITEM 13. EXHIBITS EXHIBIT INDEX
NUMBER DESCRIPTION ------ ----------- 3.1 Articles of Incorporation # 3.2 Bylaws * 4.1 Specimen common stock certificate * 4.2 Lotus Bancorp, Inc. Organizer Warrant Agreement * 4.3 Lotus Bancorp, Inc. Shareholder Warrant Agreement * 10.1 Form of Lotus Bancorp, Inc. 2007 Stock Incentive Plan * 10.2 Employment Agreement by and between Lotus Bancorp, Inc. and Satish Jasti * 10.3 Employment Agreement by and between Lotus Bancorp, Inc. and Richard Bauer * 10.4 Employment Agreement by and between Lotus Bancorp, Inc. and Christer D. Lucander ## 10.5 Lease Agreement by and between Lotus Bancorp, Inc. and Butwin Associates LLC # 11 Computation of Per Share Earnings ** 14 Code of Ethics + 21 Subsidiaries + 31.1 Rule 13a-14(a) Certification of Chief Executive Officer 31.2 Rule 13a-14(a) Certification of Chief Financial Officer 32 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
# Previously filed as an exhibit to the registration statement amendment filed August 14, 2006 and incorporated into this report by reference * Previously filed as an exhibit to the registration statement filed June 16, 2006 and incorporated into this report by reference ## Previously filed as an exhibit to the Form 8-K filed February 13, 2008 and incorporated into this report by reference + Previously filed as an exhibit to the Form 10-KSB filed March 30, 2007 and incorporated into this report by reference ** See Consolidated Statement of Operations on Page 25 of this Form 10-KSB. 50 ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES AUDIT FEES Audit fees and expenses billed to the Company by Plante & Moran, PLLC for the audit of the Company's financial statements for the fiscal years ended December 31, 2007 and for review of the Company's financial statements included in the Company's quarterly reports on Form 10-Q, which were performed by UHY LLP for the March 31, 2007 period, are as follows: 2007 $49,070 AUDIT RELATED FEES Audit related fees and expenses billed to the Company by Plante & Moran, PLLC for the fiscal year 2007 for services related to the performance of the audit or review of the Company's financial statements that were not included under the heading "Audit Fees," are as follows (certain of these expenses were for services provided by UHY LLP for the March 31, 2007 period): 2007 $5,985 TAX FEES Tax fees and expenses billed to the Company for the fiscal year 2007 for services related to tax compliance, tax advice and tax planning, consisting primarily of preparing the Company's federal and state income tax returns for the previous fiscal periods and inclusive of expenses are as follows: 2007 $0 ALL OTHER FEES Fees and expenses billed to the Company by Plante & Moran, PLLC for all other services provided during the fiscal year 2007 are as follows: 2007 $0 In accordance with Section 10A(i) of the Exchange Act, before Plante & Moran, PLLC is engaged by us to render audit or non-audit services, the engagement is approved by our Audit Committee. None of the time devoted by Plante & Moran, PLLC on its engagement to audit the Company's financial statements for the year ended December 31, 2007 is attributable to work performed by persons other than Plante & Moran, PLLC employees. 51 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. LOTUS BANCORP, INC. By: /s/ Satish B. Jasti ------------------------------------ Satish B. Jasti President & Chief Executive Officer Pursuant to the requirements of the Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ Sreenivas Cherukuri Director March 31, 2008 ------------------------------------- Sreenivas Churikuri /s/ Vasudev Garlapaty Director March 31, 2008 ------------------------------------- Vasudev Garlapaty /s/ Vinaya Gavini Director March 31, 2008 ------------------------------------- Vinaya Gavini /s/ Amarnath Gowda Director March 31, 2008 ------------------------------------- Amarnath Gowda /s/ Sarada Gullapalli Director March 31, 2008 ------------------------------------- Sarada Gullapalli /s/ Ravindranath Gullapalli Director March 31, 2008 ------------------------------------- Ravindranath Gullapalli /s/ Murali Guthikinda Director March 31, 2008 ------------------------------------- Murali Guthikonda /s/ Satish Jasti Director, President & CEO March 31, 2008 ------------------------------------- Satish Jasti /s/ Sree Jasti Director March 31, 2008 ------------------------------------- Sree Jasti /s/ Lynn Jerath Director March 31, 2008 ------------------------------------- Lynn Jerath /s/ Mayur Joshi Director March 31, 2008 ------------------------------------- Mayur Joshi /s/ Shubha Kolachalam Director March 31, 2008 ------------------------------------- Shubha Kolachalam /s/ V.S. Lingham Director March 31, 2008 ------------------------------------- V.S. Lingham /s/ Krishna Malempati Director March 31, 2008 ------------------------------------- Krishna Malempati /s/ Jitendra Patel Director March 31, 2008 ------------------------------------- Jitendra Patel
52 /s/ Natvarlal Patel Director March 31, 2008 ------------------------------------- Natvarlal Patel /s/ Haranath Policherla Director March 31, 2008 ------------------------------------- Haranath Policherla /s/ Bala Setty Director March 31, 2008 ------------------------------------- Bala Setty /s/ Jay Shah Director March 31, 2008 ------------------------------------- Jay Shah /s/ Curt Shaneour Director March 31, 2008 ------------------------------------- Curt Shaneour /s/ Venkat Talasila Director March 31, 2008 ------------------------------------- Venkat Talasila
53