10QSB 1 k72363e10qsb.txt QUARTERLY REPORT FOR PERIOD END SEPTEMBER 30, 2002 U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-QSB [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . Commission File No. 333-63769 COMMUNITY SHORES BANK CORPORATION (Exact name of small business issuer as specified in its charter) Michigan 38-3423227 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 1030 W. NORTON AVENUE, MUSKEGON, MICHIGAN 49441 (Address of principal executive offices) (231) 780-1800 (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------ ------ At October 31, 2002, 1,320,000 shares of Common Stock of the issuer were outstanding. Transitional Small Business Disclosure Format: Yes No X ------ ------ Community Shores Bank Corporation Index
PART I. Financial Information Page No. --------------------- -------- Item 1. Financial Statements ........................................................ 1 Item 2. Management's Discussion and Analysis or Plan of Operation.................................................................. 11 Item 3. Controls and Procedures....................................................... 21 PART II. Other Information Item 1. Legal Proceedings............................................................. 22 Item 2. Changes in Securities ........................................................ 22 Item 3. Defaults upon Senior Securities............................................... 22 Item 4. Submission of Matters to a Vote of Security Holders........................... 22 Item 5. Other Information............................................................. 22 Item 6. Exhibits and Reports on Form 8-K.............................................. 22 Signatures............................................................................. 24 ---------- Certifications......................................................................... 25
PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) COMMUNITY SHORES BANK CORPORATION CONSOLIDATED BALANCE SHEETS (UNAUDITED)
September 30, December 31, 2002 2001 ----------------------- ----------------------- ASSETS Cash and due from financial institutions $ 8,187,393 $ 2,191,280 Interest-bearing deposits in other financial institutions 54,358 79,641 Federal funds sold 4,600,000 0 ----------------------- ----------------------- Total cash and cash equivalents 12,841,751 2,270,921 Securities Available for sale 23,435,898 24,671,925 Held to maturity (fair value of $199,487 at September 30, 2002 and $60,000 at December 31, 2001) 197,470 60,000 ----------------------- ----------------------- Total securities 23,633,368 24,731,925 Loans held for sale 906,000 0 Loans 134,781,100 118,115,580 Less: Allowance for loan losses 1,833,492 1,535,543 ----------------------- ----------------------- Net loans 132,947,608 116,580,037 Federal Home Loan Bank stock 425,000 425,000 Premises and equipment, net 3,001,489 3,173,724 Accrued interest receivable 664,268 703,433 Other assets 377,253 306,236 ----------------------- ----------------------- Total assets $ 174,796,737 $ 148,191,276 ======================= ======================= LIABILITIES AND SHAREHOLDERS' EQUITY Deposits Non interest-bearing $ 10,499,332 $ 9,217,298 Interest-bearing 124,645,008 100,931,036 ----------------------- ----------------------- Total deposits 135,144,340 110,148,334 Federal funds purchased and repurchase agreements 18,838,636 18,964,598 Federal Home Loan Bank advances 6,000,000 6,000,000 Notes payable 3,600,000 3,400,000 Accrued expenses and other liabilities 795,527 544,256 ----------------------- ----------------------- Total liabilities 164,378,503 139,057,188 Shareholders' Equity Preferred Stock, no par value: 1,000,000 shares authorized and none issued 0 0 Common Stock, no par value: 9,000,000 shares authorized, 1,273,750 and 1,170,000 shares issued and outstanding 11,675,592 10,871,211 Retained deficit (1,618,848) (2,190,931) Accumulated other comprehensive income 361,490 453,808 ----------------------- ----------------------- Total shareholders' equity 10,418,234 9,134,088 ----------------------- ----------------------- Total liabilities and shareholders' equity $ 174,796,737 $ 148,191,276 ======================= =======================
See accompanying notes to consolidated financial statements. - 1 - COMMUNITY SHORES BANK CORPORATION CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Three Months Nine Months Nine Months Ended Ended Ended Ended 09/30/02 09/30/01 09/30/02 09/30/01 ---------- --------------------------------------------- INTEREST AND DIVIDEND INCOME Loans, including fees $2,348,426 $2,274,785 $6,771,187 $6,715,460 Securities 285,012 315,698 946,231 947,882 Federal funds sold, FHLB dividends and other income 19,356 39,611 103,080 201,396 ---------- ---------- ---------- ---------- Total interest income 2,652,794 2,630,094 7,820,498 7,864,738 INTEREST EXPENSE Deposits 1,028,614 1,187,406 3,149,254 3,936,056 Repurchase agreements and federal funds purchased and other debt 73,180 120,964 230,210 343,880 Federal Home Loan Bank advances and notes payable 143,456 150,546 423,916 438,637 ---------- ---------- ---------- ---------- Total interest expense 1,245,250 1,458,916 3,803,380 4,718,573 NET INTEREST INCOME 1,407,544 1,171,178 4,017,118 3,146,165 Provision for loan losses 154,400 101,300 442,140 294,020 ---------- ---------- ---------- ---------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,253,144 1,069,878 3,574,978 2,852,145 NONINTEREST INCOME Service charges on deposit accounts 138,308 54,229 365,661 263,431 Mortgage loan referral fees 5,603 45,021 74,519 127,354 Net realized gain on sale of loans 45,825 0 60,108 0 Net realized gain on disposition of securities 0 0 0 5,036 Other 44,967 34,682 135,578 91,308 ---------- ---------- ---------- ---------- Total noninterest income 234,703 133,932 635,866 487,129 NONINTEREST EXPENSE Salaries and employee benefits 713,852 560,079 1,990,638 1,665,360 Occupancy 71,268 67,636 212,569 191,696 Furniture and equipment 113,167 118,067 336,165 344,447 Advertising 23,470 5,279 60,348 41,913 Data Processing 63,673 47,152 181,359 139,610 Professional services 46,120 74,893 195,425 225,892 Other 220,585 165,393 662,257 529,391 ---------- ---------- ---------- ---------- Total noninterest expense 1,252,135 1,038,499 3,638,761 3,138,309 ---------- ---------- ---------- ---------- INCOME BEFORE INCOME TAXES 235,712 165,311 572,083 200,965 Federal income tax expense 0 0 0 0 ---------- ---------- ---------- ---------- NET INCOME $ 235,712 $ 165,311 $ 572,083 $ 200,965 ========== ========== ========== ========== Comprehensive income $ 293,261 $ 364,810 $ 479,765 $ 567,215 ========== ========== ========== ========== Weighted average shares outstanding 1,269,402 1,170,000 1,215,861 1,170,000 ========== ========== ========== ========== Basic and diluted income per share $ 0.19 $ 0.14 $ 0.47 $ 0.17 ========== ========== ========== ==========
See accompanying notes to consolidated financial statements. - 2 - COMMUNITY SHORES BANK CORPORATION CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
Accumulated Other Total Common Retained Comprehensive Shareholders' Shares Stock Deficit Income (Loss) Equity ------------------------------------------------------------------------------ Balance, January 1, 2001 1,170,000 $ 10,871,211 $ (2,619,299) $ 241,334 $ 8,493,246 Comprehensive Income: Net Income 200,965 200,965 Unrealized gain on securities available for sale 366,250 366,250 ------------- Total comprehensive income 567,215 ------------------------------------------------------------------------------ Balance, September 30, 2001 1,170,000 $ 10,871,211 $ (2,418,334) $ 607,584 $ 9,060,461 ============================================================================== Balance, January 1, 2002 1,170,000 $ 10,871,211 $ (2,190,931) $ 453,808 $ 9,134,088 Proceeds from sale of stock, net of offering costs 103,750 804,381 804,381 Comprehensive Income: Net Income 572,083 572,083 Unrealized loss on securities available for sale (92,318) (92,318) -------------- Total comprehensive income 479,765 ------------------------------------------------------------------------------ Balance, September 30, 2002 1,273,750 $ 11,675,592 $ (1,618,848) $ 361,490 $ 10,418,234 ==============================================================================
See accompanying notes to consolidated financial statements. - 3 - COMMUNITY SHORES BANK CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
Three months Three months Nine months Nine months ended ended ended ended 09/30/02 09/30/01 09/30/02 09/30/01 ------------ ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 235,712 $ 165,311 $ 572,083 $ 200,965 Adjustments to reconcile net income to net cash from operating activities Provision for loan losses 154,400 101,300 442,140 294,020 Depreciation and amortization 98,315 109,944 291,963 323,000 Net accretion of securities (13,664) (29,799) (51,652) (107,442) Net realized gain on disposition of securities 0 0 0 (5,036) Net realized gain on sale of loans (45,825) 0 (60,108) 0 Loan originations (4,759,400) 0 (9,552,780) 0 Proceeds from loan sales 3,899,225 0 8,706,888 0 Net change in: Accrued interest receivable and other assets 14,464 (184,603) (31,852) (76,421) Accrued expenses and other liabilities 28,588 88,525 65,051 (269,828) ------------ ------------ ------------ ------------ Net cash from operating activities (388,185) 250,678 381,733 359,258 CASH FLOWS FROM INVESTING ACTIVITIES Activity in available-for-sale securities: Sales 0 0 0 0 Maturities, prepayments and calls 10,788,848 8,050,356 28,062,888 14,583,913 Purchases (10,486,409) (9,922,931) (26,681,307) (16,112,094) Activity in held-to-maturity securities: Maturities 0 0 8,571 0 Purchases (146,041) 0 (146,041) (60,000) Loan originations and payments, net (2,649,586) (9,650,498) (16,809,711) (18,257,603) Purchase of Federal Home Loan Bank stock 0 0 0 (125,000) Additions to premises and equipment (61,732) (21,486) (119,728) (218,762) ------------ ------------ ------------ ------------ Net cash used in investing activities (2,554,920) (11,544,559) (15,685,328) (20,189,546) CASH FLOWS FROM FINANCING ACTIVITIES Net change in deposits 4,977,874 3,464,205 24,996,006 11,026,793 Net change in federal funds purchased and repurchase agreements 3,255,128 290,137 (125,962) 2,801,041 Federal Home Loan Bank activity: New Advances 0 2,000,000 1,500,000 4,500,000 Maturities and payments 0 (2,500,000) (1,500,000) (2,500,000) Net proceeds from note payable 0 100,000 200,000 1,095,000 Net proceeds from stock offering 65,833 0 804,381 0 ------------ ------------ ------------ ------------ Net cash from financing activities 8,298,835 3,354,342 25,874,425 16,922,834 Net change in cash and cash equivalents 5,355,730 (7,939,539) 10,570,830 (2,907,454) Beginning cash and cash equivalents 7,486,021 11,294,411 2,270,921 6,262,326 ------------ ------------ ------------ ------------ ENDING CASH AND CASH EQUIVALENTS $ 12,841,751 $ 3,354,872 $ 12,841,751 $ 3,354,872 ============ ============ ============ ============ Supplemental cash flow information: Cash paid during the period for interest $ 1,225,810 $ 1,310,430 $ 3,707,881 $ 4,243,051
See accompanying notes to consolidated financial statements. - 4 - COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION: The unaudited financial statements as of and for the three months and nine months ended September 30, 2002 include the condensed consolidated results of operations of Community Shores Bank Corporation ("Company") and its wholly-owned subsidiary, Community Shores Bank ("Bank") and its wholly-owned subsidiary Community Shores Mortgage Company ("Mortgage Company"). These condensed consolidated financial statements have been prepared in accordance with the instructions for Form 10-QSB and Item 310(b) of Regulation S-B and do not include all disclosures required by generally accepted accounting principles for a complete presentation of the Company's financial condition and results of operations. In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair representation of the results of operations for such periods. The results for the period ended September 30, 2002 should not be considered as indicative of results for a full year. For further information, refer to the condensed consolidated financial statements and footnotes included in the Company's annual report on Form 10-KSB for the period ended December 31, 2001. Some items in the prior year financial statements were reclassified to conform to the current presentation. 2. SECURITIES The following tables represent the securities held in the Company's portfolio at September 30, 2002 and at December 31, 2001:
Gross Gross Amortized Unrealized Unrealized Fair September 30, 2002 Cost Gains Losses Value % ----------------------------------------------------------------------------------------------------------------- Available for sale: US Government and federal agency $ 12,978,006 248,351 0 $ 13,226,357 56.0 % Municipal securities 219,609 14,918 0 234,527 1.0 Mortgaged-backed securities 9,690,570 284,444 0 9,975,014 42.2 ------------------------------------------------------------------- $ 22,888,185 547,713 0 $ 23,435,898 99.2 % =================================================================== Held to maturity: Municipal securities $ 197,470 2,017 0 $ 199,487 0.8 % ===================================================================
- 5 - COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 2. SECURITIES-continued
Gross Gross Amortized Unrealized Unrealized Fair December 31, 2001 Cost Gains Losses Value % --------------------------------------------------------------------------------------------------------------- Available for sale: US Treasuries $ 499,955 0 (273) $ 499,682 2.0 % US Government and federal agency 12,129,428 391,297 (12,849) 12,507,876 50.6 Municipal securities 219,579 0 (2,212) 217,367 0.9 Mortgaged-backed securities 11,369,155 115,988 (38,143) 11,447,000 46.3 ------------------------------------------------------------------------ $ 24,218,117 507,285 (53,477) $ 24,671,925 99.8 % ======================================================================== Held to maturity: Municipal securities $ 60,000 0 0 $ 60,000 0.2 % ========================================================================
Securities decreased $1,098,557 during the first nine months of 2002. Below is the schedule of maturities for investments held at September 30, 2002:
Securities available for sale Securities held to maturity Amortized Fair Amortized Fair Cost Value Cost Value --------------------------------------------------------------------------------------------------------------------- Due in one year or less $ 9,278,769 $ 9,373,069 $ - $ - Due from one to five years 3,699,236 3,853,288 0 0 Due in more than five years 219,609 234,527 146,041 148,058 Mortgage-backed and Municipal 9,690,571 9,975,014 51,429 51,429 ---------------------------------------------------------------------------- $22,888,185 $23,435,898 $ 197,470 $ 199,487 ============================================================================
3. LOANS Loans increased $16,665,520 since December 31, 2001. The components of the outstanding balances, their percentage of the total portfolio and the percentage increase from the end of 2001 to the end of the first nine months of 2002 were as follows:
Percent September 30, 2002 December 31, 2001 Increase/ Balance % Balance % (Decrease) --------------------- ---------------------- -------------- Commercial, financial and other $ 102,480,960 76.0 % $ 89,258,193 75.6 % 14.8 % Real estate-construction 1,794,858 1.3 3,081,361 2.6 (41.8) Real estate-mortgages 5,686,480 4.2 3,761,403 3.2 51.2 Installment loans to individuals 24,818,802 18.5 22,014,623 18.6 12.7 --------------------- ---------------------- 134,781,100 100.0 % 118,115,580 100.0 % ======= ======== Less allowance for loan losses 1,833,492 1,535,543 -------------- -------------- $ 132,947,608 $ 116,580,037 ============== ==============
- 6 - COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 4. ALLOWANCE FOR LOAN LOSSES The following is a summary of activity in the allowance for loan losses account for the three month and nine month periods ended September 30, 2002 and 2001:
Three Months Three Months Nine Months Nine Months Ended Ended Ended Ended 09/30/02 09/30/01 09/30/02 09/30/01 ------------------------------------------- ------------- ------------- -------------- -------------- Beginning Balance $1,771,825 $1,382,199 $ 1,535,543 $ 1,269,050 Charge-offs (99,487) (5,063) (177,547) (116,370) Recoveries 6,754 1,351 33,356 33,087 Provision charged against operating expense 154,400 101,300 442,140 294,020 ------------- ------------- -------------- -------------- Ending Balance $1,833,492 $1,479,787 $ 1,833,492 $ 1,479,787 ============= ============= ============== ==============
5. DEPOSITS Deposit balances increased $24,996,006 since December 31, 2001. The components of the outstanding balances, their percentage of the total portfolio and the percentage increase from the end of 2001 through the first nine months of 2002 were as follows:
Percent September 30, 2002 December 31, 2001 Increase/ Balance % Balance % (Decrease) ------------------------ ------------------------- ------------- Noninterest-bearing Demand $ 10,499,332 7.8 % $ 9,217,298 8.4 % 13.9 % Interest-bearing Checking 23,299,745 17.2 20,979,462 19.0 11.1 Money Market 29,133,275 21.6 18,612,647 16.9 56.5 Savings 3,275,273 2.4 2,332,538 2.1 40.4 Time, under $100,000 33,686,898 24.9 30,913,935 28.1 9.0 Time, over $100,000 35,249,817 26.1 28,092,454 25.5 25.5 ------------------------ ------------------------- Total Deposits $ 135,144,340 100.0 % $ 110,148,334 100.0 % ======================== =========================
6. SHORT-TERM BORROWINGS Both federal funds purchased and repurchase agreements were outstanding at December 31, 2001. At September 30, 2002, the Company's short-term borrowings were made up of repurchase agreements only. Since year-end 2001, repurchase agreements increased $6,574,038. The September 30, 2002 and December 31, 2001 information was as follows: - 7 - COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 6. SHORT-TERM BORROWINGS-continued
Repurchase Federal Funds Agreements Purchased --------------- ---------------- Outstanding at September 30, 2002 $ 18,838,636 $ 0 Average interest rate at period end 1.94% 0.00% Average balance during year 15,036,410 460,623 Average interest rate during year 1.98% 2.10% Maximum month end balance during year 18,838,636 0 Outstanding at December 31, 2001 $ 12,264,598 $ 6,700,000 Average interest rate at year end 2.04% 1.82% Average balance during year 12,282,957 1,053,836 Average interest rate during year 3.36% 3.16% Maximum month end balance during year 14,589,092 6,700,000
7. FEDERAL HOME LOAN BANK BORROWINGS The Bank was approved in the first quarter of 1999 to be a member of the Federal Home Loan Bank of Indianapolis. Based on its current Federal Home Loan Bank Stock holdings the Bank has the capacity to borrow $8,500,000. Each borrowing requires a direct pledge of securities or loans. At this time, the Bank has securities with a market value of $6,228,301 pledged to the Federal Home Loan Bank to support current borrowings. Details of the Bank's outstanding borrowings at both September 30, 2002 and December 31, 2001 are:
Current Interest Maturity Date: Rate September 30, 2002 December 31, 2001 ------------------------------ -------------- ------------------------ ----------------------- March 24, 2010 5.99 $1,500,000 $1,500,000 November 3, 2010 5.95 2,000,000 2,000,000 December 13, 2010 5.10 2,500,000 2,500,000 ------------------------ ----------------------- Total outstanding at $6,000,000 $6,000,000 ======================== =======================
8. NOTES PAYABLE Since June 28, 2000, the Company borrowed $3,600,000 from four of its Directors and Community Shores LLC. Community Shores LLC (the "LLC") was formed by 7 of the Company's Directors for the purpose of obtaining and lending money to the Company. The members of the LLC are David C. Bliss, Gary F. Bogner, Robert L. Chandonnet, Dennis L. Cherette, Bruce J. Essex, Michael D. Gluhanich and Jose A. Infante. Two of the - 8 - COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 8. NOTES PAYABLE-continued LLC members, Mr. Gluhanich and Mr. Chandonnet, lent money directly as well as taking part in the LLC. A summary of the loans is given below:
------------------------------------------------------------------------------- Loan from: Aggregate Current Maturity Principal Rate Amount ------------------------------------------------------------------------------- Robert L. Chandonnet $ 200,000 6.25% June 30, 2008 Michael D. Gluhanich $ 100,000 6.25% June 30, 2008 Donald E. Hegedus $ 500,000 6.25% June 30, 2008 John L. Hilt $ 750,000 6.25% June 30, 2008 Community Shores LLC $2,050,000 6.25% June 30, 2008 ------------------------------------------------------------------------------- Total $3,600,000 -------------------------------------------------------------------------------
The rate on the above notes is floating and is officially defined as 1.50% over the US Bank, N.A. Prime rate. US Bank's current prime rate is 4.75%. Interest is owed quarterly in arrears on the fifteenth of April, July, October and January until the principal of these Notes is paid or made available for payment. The notes may be prepaid without any prepayment penalty with at least one day's prior written notice. The principal and interest related to these Notes is expressly subordinated to any and all senior debt of the Company. The proceeds from these Notes were primarily used to infuse capital into the Bank to maintain sufficient capital ratios to comply with banking regulations. 9. COMMITMENTS AND OFF-BALANCE SHEET RISK Some financial instruments are used to meet financing needs and to reduce exposure to interest rate changes. These financial instruments include commitments to extend credit and standby letters of credit. These involve, to varying degrees, credit and interest-rate risk in excess of the amount reported in the financial statements. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment, and generally have fixed expiration dates. Standby letters of credit are conditional commitments to guarantee a customer's performance to a third party. Exposure to credit loss if the other party does not perform is represented by the contractual amount for commitments to extend credit and standby letters of credit. Collateral or other security is normally obtained for these financial instruments prior to their use, and many of the commitments are expected to expire without being used. A summary of the notional and contractual amounts of outstanding financing instruments with off-balance-sheet risk as of September 30, 2002 and December 31, 2001 follows: - 9 - COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 9. COMMITMENTS AND OFF-BALANCE SHEET RISK-continued
September 30, December 31, 2002 2001 --------------- -------------- Letters of credit $ 265,000 $ 1,237,000 Commercial unused lines of credit 24,333,430 26,083,000 Consumer unused lines of credit 6,262,523 4,986,000 Residential construction commitments 407,927 723,000
Commitments to make loans generally terminate one year or less from the date of commitment and may require a fee. Since many of the above commitments expire without being used, the above amounts do not necessarily represent future cash commitments. No losses are anticipated as a result of these transactions. 10. REGULATORY MATTERS The Company and Bank are subject to regulatory capital requirements administered by the federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulator approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required.
Capital to risk weighted assets ----------------------- Tier 1 Capital Total Tier 1 to average assets ----------- --------- -------------------- Well capitalized 10 % 6 % 5 % Adequately capitalized 8 4 4 Undercapitalized 6 3 3
- 10 - COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 10. REGULATORY MATTERS-continued Actual capital levels and minimum required levels at September 30, 2002 for the Company and Bank were:
Actual Adequately Capitalized Well Capitalized ------------------------- ------------------------ ------------------------ September 30, 2002 Amount Ratio Amount Ratio Amount Ratio ------------------------- ------------------------ ------------------------ -------------------------- Total capital (to risk- weighted assets) Consolidated $ 15,490,236 10.51 % $ 11,788,928 8.00 % $ 14,736,160 10.00 % Bank 14,952,408 10.15 11,788,046 8.00 14,735,058 10.00 Tier 1 capital (to risk- weighted assets) Consolidated 10,056,744 6.82 5,894,464 4.00 8,841,696 6.00 Bank 13,118,917 9.90 5,894,023 4.00 8,841,035 6.00 Tier 1 capital (to average assets) Consolidated 10,056,744 6.05 6,653,695 4.00 8,317,119 5.00 Bank 13,118,917 7.88 6,655,263 4.00 8,319,079 5.00
The Company and the Bank were in the well capitalized category at September 30, 2002. The Company is closely monitoring the Bank's growth and for the foreseeable future expects to infuse additional capital as necessary to maintain at least a 10% (well capitalized) total capital to risk weighted assets ratio. Future capital contributions will be made from the proceeds received from an unregistered sale of Company stock. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION The discussion below details the financial results of the Company and its wholly owned subsidiaries, the Bank and the Mortgage Company, through September 30, 2002 and is separated into two parts which are labeled, Financial Condition and Results of Operations. The part labeled Financial Condition compares the financial condition at September 30, 2002 to that at December 31, 2001. The part labeled Results of Operations discusses the three month and nine month periods ended September 30, 2002 as compared to the same periods of 2001. Both parts should be read in conjunction with the interim condensed consolidated financial statements and footnotes included in Item 1 of this Form 10-QSB. - 11 - COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS This discussion and analysis and other sections of this 10-QSB contains forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about the Company, the Bank and the Mortgage Company. Words such as "anticipates", "believes", "estimates", "expects", "forecasts", "intends", "is likely", "plans", "projects", variations of such words and similar expressions are intended to identify such forward-looking statements. These forward-looking statements are intended to be covered by the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("Future Factors") that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. The Company undertakes no obligation to update, amend, or clarify forward looking statements, whether as a result of new information, future events (whether anticipated or unanticipated), or otherwise. Future Factors include changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulation; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; changes in the national and local economy; and other factors, including risk factors, referred to from time to time in filings made by the Company with the Securities and Exchange Commission. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement. FINANCIAL CONDITION Total assets increased by $26,605,461 to $174,796,737 at September 30, 2002 from $148,191,276 at December 31, 2001. This is an 18% increase in assets during the first nine months of 2002. Growth is attributable to an increase in loan volume as well as higher balances held at other financial institutions and federal funds being sold. Management continues to focus on small- to medium-sized business customers, the original strategy since opening in January 1999. Cash and cash equivalents increased by $10,570,830 to $12,841,751 at September 30, 2002 from $2,270,921 at December 31, 2001. This increase was the result of an additional $5,996,113 being held at other financial institutions. On September 30 2002, due to an unexpected increase in deposits, management chose to leave an additional $2,000,000 in its Federal Reserve Account overnight due to its favorable risk weighting when computing the Bank's quarter end capital position. The increased balances held in the Bank's correspondent account are simply reflective of general growth of the Bank's customer base. Finally there was $4,600,000 in federal funds sold on September 30, 2002 compared to none being sold on December 31, 2001. - 12 - COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS Securities held decreased by $1,098,557 in the first nine months of 2002. Security purchases are mainly driven by general growth in the Bank's repurchase agreement account holdings. A repurchase agreement is not considered a deposit by the FDIC and is therefore not eligible for FDIC insurance coverage. The recorded liability is treated like a short-term borrowing of the Bank. To secure the short-term borrowing (repurchase agreement), balances held by customers are typically collateralized by high quality government securities held within the Bank's security portfolio. On the last day of the quarter, a deposit of $2,064,967 was made into the repurchase product however there was an insufficient amount of pledged securities in the Bank's investment portfolio to cover the increase. On October 1, 2002, the Bank purchased securities with a value of $2,496,917 for the purpose of covering the deficiency. The purchased securities settled on October 2, 2002. If the repurchase balances continue to increase, the purchase of additional Treasuries and Agencies would be required to fulfill the collateralization requirement. Loans held for sale totaled $906,000 at September 30, 2002 compared to none being held for sale at year-end 2001. The entire balance is made up of real estate mortgage loans. Since opening Community Shores Mortgage Company in March of this year, mortgage loans are originated by the Mortgage Company and placed in a portfolio of loans held for sale. Usually within 30 days of origination, the loans are sold for a gain to various venders on a servicing released basis. At this time it is not the intention of management to retain fifteen and thirty-year fixed rate mortgage loans due to the risk involved from an asset liability management perspective. Total loans climbed to $134,781,100 at September 30, 2002 from $118,115,580 at December 31, 2001. Of the $16,665,520 increase experienced, 79% occurred in the commercial loan portfolio and 16% occurred in the installment loan portfolio. The "wholesale" banking focus applied since opening in 1999 continued during the first nine months of 2002. Presently, the commercial category of loans comprises 76% of the Bank's total loan portfolio. There are five experienced commercial lenders on staff devoted to pursuing and originating these types of loans. Growth was also experienced on the "retail" lending side. Installment loans increased $2,804,179 or 13%, over the balance reported at December 31, 2001. Growth in this category was mostly the result of new business in direct and indirect automobile loans and home equity loans. Management is experiencing a softening in loan volume in spite of the favorable interest rate environment but still remains optimistic about future opportunities in the Bank's market resulting from the acquisition of a competitor bank by an out-of-state bank holding company. The loan maturities and rate sensitivity of the loan portfolio at September 30, 2002 have been included below: - 13 - COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS
Within Three to One to After three twelve five five months months years years Total -------------------------------------------------------------------------------- Commercial, financial and other $14,278,829 $34,065,833 $52,602,717 $1,533,581 $102,480,960 Real estate-construction 922,140 872,718 0 0 1,794,858 Real estate-mortgages 30,064 142,340 934,886 4,579,190 5,686,480 Installment loans to individuals 1,515,355 3,263,139 16,946,332 3,093,976 24,818,802 -------------------------------------------------------------------------------- $16,746,388 $38,344,030 $70,483,935 $9,206,747 $134,781,100 ================================================================================ Loans at fixed rates 2,741,697 5,200,202 56,773,187 6,700,107 $71,415,193 Loans at variable rates 14,004,691 33,143,828 13,710,748 2,506,640 63,365,907 -------------------------------------------------------------------------------- $16,746,388 $38,344,030 $70,483,935 $9,206,747 $134,781,100 ================================================================================
The loan portfolio is reviewed and analyzed on a regular basis for the purpose of estimating probable incurred credit losses. The allowance for loan losses is adjusted accordingly to maintain an adequate level based on that analysis. At September 30, 2002, the allowance totaled $1,833,492 or approximately 1.36% of gross loans outstanding. Management has determined that this is an appropriate level based on their detailed review of the loan portfolio including comparison of allowance levels to those maintained by other institutions with similar, but seasoned loan portfolios. The allocation of the allowance at September 30, 2002 was as follows:
September 30, 2002 December 31, 2001 Percent of Percent of allowance allowance Balance at End of Period Applicable to: related to related to Amount loan category Amount loan category ---------------- ---------------- --------------- ---------------- Commercial $1,476,092 80.5 % $1,180,208 76.9 % Residential real estate 65,982 3.6 68,268 4.4 Installment 291,418 15.9 287,067 18.7 Unallocated 0 0.0 0 0.0 ---------------- ---------------- --------------- ---------------- Total $1,833,492 100.0 % $1,535,543 100.0 % ================ ================ =============== ================
Management will continue to monitor the allocation and make necessary adjustments to the provision and the allowance based on portfolio concentration levels, actual loss experience and the financial condition of the borrowers. As such, an additional $442,140 was provided for since December 31, 2001. At the end of September 2002, loans 30-59 days past due totaled $1,004,920 up from $735,005 at December 31, 2001. Approximately $574,000 of the increase in these past due balances was related to commercial loans which was offset by a decrease in retail past dues of $304,000. One commercial loan in the 30-59 days past due category totaling approximately $254,000 had matured. In October the loan was renewed and was removed from the past due listings. There was a total of $171,980 past due 60-89 days and $316,532 past due - 14 - COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS more than 89 days at the end of 2001 compared to $294,321 past due 60-89 days and $1,032,174 past due more than 89 days after the first nine months of 2002. Approximately 96% of the $716,000 increase in the more than 89 day category is related to Commercial loans. One commercial loan totaling approximately $470,000 or 46% of the category was paid in full in October. At September 30, 2002, the Bank had seven non-accrual loans with an aggregate total of $328,516. The Bank had no non-accrual loans at the end of December 2001. Net charge-offs recorded in 2001 were $128,527. In the first nine months of 2002, the Bank had net charge-offs of $144,191. Although non-accruals and net charge-offs have increased since year-end 2001, management feels that it is a factor of both the weak economy and the normal seasoning of the portfolio. Bank premises and equipment decreased $172,235 to $3,001,489 at September 30, 2002 from $3,173,724 at December 31, 2001. Accumulated depreciation and amortization represented $1,001,789 at year-end compared to $1,293,762 at September 30, 2002. No significant capital expenditures were made in the first nine months of 2002. Deposit balances were $135,144,340 at September 30, 2002 up from $110,148,334 at December 31, 2001. Non-interest bearing checking increased $1,282,034 or 14% since 2001 year-end. The increase in the categories of interest bearing checking and money market accounts was $12,840,911 (32%) for the first three quarters of 2002. During the last quarter, one of the Bank's large public fund customers made a significant money market deposit. Time deposits and savings accounts increased $10,873,061 or 18% since December 31, 2001. Sometimes management chooses to fund a portion of the Bank's loan growth by obtaining brokered deposits. As such, brokered deposits went from 23% to 26% of total deposits during the first three quarters of 2002. Brokered deposits are time deposits obtained from depositors located outside of our market area and are placed with the Bank by a deposit broker. Local initiatives have also been successful in the first nine months of 2002. As a result of three certificate of deposit campaigns in the first half of 2002, the Bank managed to book over $6,828,000 in new deposits. Although the bookings only netted a local deposit increase of $1,620,562 it was viewed as a positive event to retain such a significant portion of the maturing deposits with the rate environment as it is currently. Repurchase agreements increased $6,574,038 since December 31, 2001 with $2,064,967 of the growth occurring on the last day of the quarter. The nine month growth figure represents an increase of 54% over the balance at 2001 year-end. The growth is attributable to existing customers increasing their carrying balances from those held at year-end as well as the addition of new customers using this banking product. The Bank's Federal Home Loan Bank ("FHLB") advances outstanding was $6,000,000 at both September 30, 2002 and December 31, 2001. On January 9, 2002, the Bank arranged to borrow $1,500,000 for 180 days at a variable rate. The proceeds were used to resolve a short-term liquidity deficit at the beginning of 2002. The loan was repaid on January 22, 2002. In September, two of the three putable advances owned by the Bank were eligible for conversion to a floating rate at the option of the FHLB. The FHLB did not exercise its right in either case. The putable advances of $2,500,000 and $1,500,000 continue to accrue interest at rates of 5.10% and 5.99% respectively. Going forward the FHLB will have the - 15 - COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS right to exercise its option on both notes every ninety days. In the event that either note converts to a floating rate, management has the right to pay off the note with no pre-payment penalty. At this time, it is not anticipated that either advance will convert to a floating rate given the nature of the current rate environment. As of September 30, 2002, the Company had borrowed $3,600,000 from some of its Directors and Community Shores LLC for the purpose of infusing capital into the Bank and to provide cash for the operating expenses of the Company. The current balance is $200,000 more than the outstanding balance on December 31, 2001. This debt is subordinated to all senior debt of the Company. The notes have a floating rate and are currently accruing interest at 6.25% per annum. Interest payments are due quarterly on the fifteenth of the month. The next scheduled interest payment is due on January 15, 2003. During 2002's second quarter, $200,000 was contributed to the Bank's capital to achieve a well capitalized risk based capital position. During the third quarter of 2002, there was no capital contribution necessary due to the better than expected earnings at the Bank. Next quarter should asset growth rates exceed earnings, the Company expects once again to contribute capital to enable the Bank to maintain a well capitalized capital ratio. During the first three months of 2002, the Company evaluated several possible strategies to effectively increase capital levels. The most efficient way to achieve the desired results was determined to be an unregistered sale of Company stock. Since May of 2002, the Company obtained $804,381 of capital through the sale of common stock. These additional funds are expected to be contributed to the Bank to maintain the desired capital ratio. The Company may obtain more capital using this same strategy in the near future. RESULTS OF OPERATIONS The net income for the third quarter of 2002 was $235,712 which compares favorably to the net income of $165,311 recorded in the third quarter of 2001. At September 30, 2002, the Company's year to date income of $572,083 was an improvement of 185% over reported net income of $200,965 for the nine months of last year. For the third quarter and first nine months of 2002, the annualized return on the Company's average total assets was .57% and .46% respectively. The Company's return on average equity was 9.17% for the third quarter of 2002 and 7.89% for the first nine months. At September 30, 2002, the ratio of average equity to average assets was 6.18% for the second quarter and 5.80% for the first nine months of 2002. The Company's retained deficit was $1,618,848 at September 30, 2002 compared to $2,190,931 at December 31, 2001. The actual operating results for the third quarter and first nine months of 2002 were better than management's internal, budgeted goal. The main contributing factor to the above results is the improvement in net interest income. The following tables sets forth certain information relating to the Company's consolidated average interest earning assets and interest-bearing liabilities and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing annualized income or expenses by the average daily balance of assets or liabilities, respectively, for the periods presented. - 16 - COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS
Nine months ended September 30: 2002 2001 Average Average Average Average balance Interest rate balance Interest rate --------------------------------------- -------------------------------------- Assets Federal funds sold and interest-bearing deposits with other financial institution $ 8,100,029 $ 103,080 1.70 % $ 5,085,942 $ 181,889 4.77 % Investment securities 23,945,942 946,231 5.27 20,112,675 967,389 6.41 Loans (including held for sale) 128,085,640 6,771,187 7.05 103,716,254 6,715,460 8.63 --------------------------------------- -------------------------------------- 160,131,611 7,820,498 6.51 128,914,871 7,864,738 8.13 Other assets 6,524,190 6,862,260 ---------------- ---------------- $ 166,655,801 $ 135,777,131 ================ ================ Liabilities and Shareholders' Equity Interest-bearing deposits $ 121,161,755 $3,149,254 3.47 $ 97,298,005 $3,936,056 5.39 Federal funds purchased and repurchase agreements 15,497,033 230,210 1.98 12,105,822 343,880 3.79 Note payable and Federal Home Loan Bank advances 9,611,722 423,916 5.88 8,763,388 438,637 6.67 --------------------------------------- -------------------------------------- 146,270,510 3,803,380 3.47 118,167,215 4,718,573 5.32 ------------- ------------- Noninterest-bearing deposits 10,031,176 8,222,661 Other liabilities 691,766 726,039 Shareholders' Equity 9,662,349 8,661,216 ---------------- ---------------- $ 166,655,801 $ 135,777,131 ================ ================ Net interest income $4,017,118 $3,146,165 ============= ============= Net interest spread on earning assets 3.04 % 2.81 % ========== ========= Net interest margin on earning assets 3.34 % 3.25 % ========== =========
The net interest spread on average earning assets increased 23 basis points to 3.04% since September 30, 2001. The net interest margin improved 9 basis points from 3.25% at September 30, 2001 to 3.34% at September 30, 2002. Year to date net interest income was $4,017,118 compared to a figure of $3,146,165 for the same nine months in 2001, an increase of $870,953 or 28%. Interest income recorded for the first three quarters of 2002 was generated primarily from booking loans, purchasing securities, and selling federal funds. Year to date interest income through September 30, 2002 was $7,820,498 compared to $7,864,738 recorded for the same nine month period in 2001. The net decrease reflects .6% less interest income recorded so far in 2002 compared to 2001. The average rate earned on interest-earning assets was 6.51% for the nine months ended September 30, 2002 compared to 8.13% for the same period in 2001. This decrease of 162 basis points resulted primarily from differences in the Bank's internal prime rate. All changes, no matter what direction, to the Bank's internal prime rate affect interest earned on variable rate loans and new loan volume. At September 30, 2002, 47% of the Bank's loan portfolio was variable and average loans outstanding had increased $24,369,386 over the same period end one-year earlier. Additionally, interest expense incurred on deposits, repurchase agreements, federal funds purchased, Federal Home Loan - 17 - COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS Bank advances and Notes Payable decreased 19% for the first nine months of the year compared to the first nine months of 2001. This category totaled $3,803,380 through September 30, 2002 which was a $915,193 reduction over the total recorded for the same period in 2001. The favorable change in the net interest margin is directly attributable to the Bank's success in securing a lower cost of funds in a declining rate environment. The average rate paid on interest-bearing products was 185 basis points less than what was paid a year earlier. Similarly, an analysis of the third quarter information shows the Company's ability to maintain a lower cost of funds. The yield on interest earning liabilities decreased by 139 basis points in the third quarter of 2002 compared to the same period last year. In spite of this improvement, the net interest margin through September 30, 2002 decreased by 1 basis point compared to the same period one year earlier. The 182 basis point difference (lower) in the Bank's internal prime rate during 2001's and 2002's third quarter period is mainly responsible for the decrease. Details of the quarter to quarter comparison are shown below.
Three months ended September 30: 2002 2001 Average Average Average Average balance Interest rate balance Interest rate --------------------------------------- -------------------------------------- Assets Federal funds sold and interest-bearing deposits with other financial institution $ 4,576,060 $ 19,356 1.69 % $ 3,484,386 $ 31,845 3.66 % Investment securities 22,254,005 285,012 5.12 20,757,324 323,464 6.23 Loans (including held for sale) 133,562,972 2,348,426 7.03 108,783,838 2,274,785 8.36 --------------------------------------- -------------------------------------- 160,393,037 2,652,794 6.62 133,025,548 2,630,094 7.91 Other assets 5,949,343 6,895,757 ---------------- ---------------- $ 166,342,380 $ 139,921,305 ================ ================ Liabilities and Shareholders' Equity Interest-bearing deposits $ 120,067,131 $1,028,614 3.43 $ 97,931,869 $1,187,406 4.85 Federal funds purchased and repurchase agreements 15,054,306 73,180 1.94 13,736,257 120,964 3.52 Note payable and Federal Home Loan Bank advances 9,600,000 143,456 5.98 9,180,434 150,546 6.56 --------------------------------------- -------------------------------------- 144,721,437 1,245,250 3.44 120,848,560 1,458,916 4.83 ------------- ------------- Noninterest-bearing deposits 10,575,151 9,811,729 Other liabilities 765,594 463,845 Shareholders' Equity 10,280,198 8,797,171 ---------------- ---------------- $ 166,342,380 $ 139,921,305 ================ ================ Net interest income $1,407,544 $1,171,178 ============= ============= Net interest spread on earning assets 3.17 % 3.08 % ========== ========= Net interest margin on earning assets 3.51 % 3.52 % ========== =========
As the Bank's cost of funds declines and prime rate changes continue being a possibility, asset liability management has become an important tool for assessing and monitoring interest rate sensitivity. Management of interest rate sensitivity attempts to avoid widely varying net interest - 18 - COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS margins and achieve consistent net interest income through periods of changing interest rates. Asset liability management aids the Company in achieving reasonable and predictable earnings and liquidity while maintaining a balance between interest-earning assets and interest-bearing liabilities. Liquidity management involves the ability to meet the cash flow requirements of the Company's customers. These customers may be either borrowers with credit needs or depositors wanting to withdraw funds. Interest rate sensitivity varies with different types of earning assets and interest-bearing liabilities. Overnight investments, on which rates change daily, and loans tied to the prime rate, differ considerably from long term investment securities and fixed rate loans. Time deposits over $100,000 and money market accounts are more interest sensitive than regular savings accounts. Comparison of the repricing intervals of interest-earning assets to interest-bearing liabilities is a measure of interest sensitivity gap. Balancing this gap is a continual challenge in a changing rate environment. The Company uses a sophisticated computer program to perform analysis of interest rate risk, assist with asset liability management, and model and measure interest rate sensitivity. Details of the repricing gap at September 30, 2002 were:
Interest rate sensitivity period Within Three to One to After three twelve five five months months years years Total ----------------------------------------------------------------------------------- Earning assets Interest-bearing deposits in other financial institutions $ 54,358 $ 0 $ 0 $ 0 $ 54,358 Federal funds sold 4,600,000 0 0 0 4,600,000 Securities (including FHLB stock) 8,829,707 5,415,926 7,928,682 1,884,053 24,058,368 Loans held for sale 0 0 0 906,000 906,000 Loans 73,711,252 7,933,859 51,151,739 1,984,250 134,781,100 ----------------------------------------------------------------------------------- 87,195,317 13,349,785 59,080,421 4,774,303 164,399,826 Interest-bearing liabilities Savings and checking 55,708,293 0 0 0 55,708,293 Time deposits<$100,000 3,820,345 10,178,018 19,688,535 0 33,686,898 Time deposits>$100,000 4,765,990 11,026,335 19,457,492 0 35,249,817 Repurchase agreements and Federal funds purchased 18,838,636 0 0 0 18,838,636 Notes payable and Federal Home Loan Bank advances 7,600,000 0 2,000,000 0 9,600,000 ----------------------------------------------------------------------------------- 90,733,264 21,204,353 41,146,027 0 153,083,644 ----------------------------------------------------------------------------------- Net asset (liability) repricing gap $(3,537,947) $ (7,854,568) $17,934,394 $ 4,774,303 $ 11,316,182 =================================================================================== Cumulative net asset (liability) repricing gap $(3,537,947) $(11,392,515) $ 6,541,879 $11,316,182 ===================================================================
Currently the Bank has a negative twelve month repricing gap which indicates that the bank is liability sensitive. This position implies that decreases to the national federal funds rate would have more of an impact on interest expense than on interest income if there were a parallel shift in rates. For instance if the Bank's internal prime rate went down by 25 basis points and every - 19 - COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS interest earning asset and interest bearing liability on the Bank's September 30, 2002 balance sheet adjusted simultaneously by the same 25 basis points, more liabilities would be affected than assets. At this point in time it would not be prudent to assume that future reductions in the Bank's internal prime could be completely absorbed by reductions to the Bank's deposit rates. Some deposit rates are reaching the bottom limit of what can be paid in today's marketplace. The provision for loan losses for the third quarter and the first nine months of 2002 were $154,400 and $442,140 compared to a figures of $101,300 and $294,020 for the same periods in 2001. Management believes that the allowance level is adequate and justifiable based on the factors discussed earlier (see Financial Condition). Management will continue to review the allowance with the intent of maintaining it at an appropriate level. The provision may be increased or decreased in the future as management continues to monitor the loan portfolio and actual loan loss experience. Non-interest income recorded in the third quarter totaled $234,703 and represented an increase of 75% over last year's third quarter. Through September 30, 2002, non-interest income was $635,866 compared to a figure of $487,129 for the first nine months of 2001. Service charge income was $84,079 higher between 2002's third quarter and the similar quarter in 2001. About $51,000 of the increase was related to non-sufficient funds charges which is typically a symptom of the economic environment. The significant increases experienced in this type of fee income over the past nine months are not guaranteed and should not be counted on for future contributions to earnings. The other portion of the increase is from service charges on deposits. Management believes that increases to fee income of this type will continue to increase in future quarters due to anticipated growth in the number of deposit accounts. Conversely, mortgage loan referral fees recorded in the third quarter of 2002 decreased $39,418 from the figure shown in the third quarter of 2001. Since the Bank opened Community Shores Mortgage Company in March of this year the mortgage loans are sometimes handled differently resulting in an actual sale of a booked loan. Profits from these loan sales were $45,825 for the third quarter. On a year to date basis, mortgage loan referral fees and gain on loan sales totaled $134,627 compared to $127,354 of mortgage loan referral fees being realized through September 30 of 2001. It is difficult to predict future contributions of mortgage related fee income to non-interest income because of its dependence on interest rates, which are subject to market forces. Other non-interest income consists of a variety of categories. The one showing the most dramatic improvement from last year's first nine months to this year's was brokerage commissions. The total increase in this category was roughly $10,000 or 22% of the improvement in other non-interest income on a year to date basis. Non-interest expenses for the first three quarters of 2002 increased 16% over the same nine month period in 2001. The figure for the first nine months of 2002 was $3,638,761 compared to a total of $3,138,309 for the first nine months of 2001. The third quarter expenses increased over the similar period one year ago by a total of $213,636. Salaries and benefits comprised 65% of the year to date increase and 72% of the third quarter increase. There were an additional 10.0 full-time equivalent employees at September 30, 2002 compared to September 30, 2001. The group insurance portion of this expense category has risen dramatically not only due to staff - 20 - COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS additions but also increased premiums. Of the total increase in salary and benefits on a year-to-date basis, 13% is related to additional group insurance expenses. Occupancy and furniture and equipment expenses declined $1,268 for the third quarter and increased $12,591 (3%) for the first nine months of 2002 compared to the similar periods in 2001. On a year-to-date basis, higher maintenance contract costs and an increase in property taxes for the Bank's main office were mostly the cause of this fluctuation. Advertising expense has escalated on both a quarterly and a year-to-date basis. During 2002's third quarter the recorded expense was $18,191 higher than the similar period of 2001. A large portion of the expense was related to a community picnic that was hosted by the Bank on June 28. Another portion of the increase was related to a small level sponsorship of a local pro hockey team, the Muskegon Fury. Data processing expenses, as expected, have increased as a result of the Bank's expanding customer base as well as the addition of the personal internet banking capability. This category has grown 30% in the first nine months of 2002 and 35% for the third quarter compared to the same periods in 2001. These increases in data processing costs are responsible for 8% of the total increase in non-interest expenses so far this year. Expenses of this nature are an unavoidable cost of doing business for a financial institution. Professional services expense decreased by $30,467 for the first nine months and $28,773 for the third quarter when comparing the year to date and quarterly figures reflected through September 30, 2002 with the similar periods one year ago. The line item showing other non-interest expenses has increased $55,192 compared to the similar quarter in 2001 and $132,866 compared to the same nine month period last year. In 2001, the Bank began paying its directors a fee for attending scheduled Board and Committee meetings. By September 30, 2002, the Bank had accrued $46,501 in director's fees versus $17,100 accrued in 2001. The change in this category for the first nine months of the year accounts for 17% of the increase in other non-interest expense on a year to date basis. The repo and collection expenses related to problem loans have increased and are responsible for 9% of the change in the other non-interest expense on a year-to-date basis. Expenses of this nature are a necessary cost of doing business as a loan portfolio begins to experience increased charge-offs and past due statistics. In the first nine months of 2002 the Bank accrued State of Michigan Business Taxes of $20,626 compared to none being accrued for the same time period in 2001. The increase in this category is responsible for 12% of the year to date increase in other non-interest expenses. No Federal Income Tax accruals were made for either the first three quarters of 2002 or that of 2001. Given the fact that the Company is now profitable the net operating losses accumulated in the first years of operation are being used to offset the federal tax liability on current profits. At this time it is estimated that the net operating losses will continue offsetting income throughout 2002. ITEM 3. CONTROLS AND PROCEDURES Within the 90-day period prior the filing date of this report, an evaluation was carried out under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures. Based on the evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures were, to the best of their knowledge, effective on the date of the evaluation with respect to information required to be disclosed by the Company in reports that it files or submits under the Exchange Act. Subsequent to the date of the evaluation, Our Chief Executive Officer and Chief Financial Officer have concluded that there have been no significant changes in the Company's internal controls - 21 - ITEM 3. CONTROLS AND PROCEDURES-continued or in other factors that could affect its internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time, the Company, the Bank or the Mortgage Company may be involved in various legal proceedings that are incidental to their business. In the opinion of management, neither the Company, the Bank nor the Mortgage Company is a party to any current legal proceedings that are material to the financial condition of the Company, the Bank or the Mortgage Company, either individually or in the aggregate. ITEM 2. CHANGES IN SECURITIES During the third quarter of 2002, the Company sold 10,000 shares of unregistered common stock in a privately negotiated sale to one individual. Since May of this year, 103,750 shares of unregistered common stock have been sold in similar transactions. All of the sales were made at a price of $8.00 per share in cash. Of these shares, 81,250 were sold in May, 12,500 were sold in June and 10,000 were sold in August. Each of the purchasers was believed to be an accredited investor under Regulation D of the Securities Act of 1933. Each of the sales was made in reliance on an exemption from registration under Rule 506 of Regulation D or Section 4(2) under the Securities Act of 1933. The 103,750 shares of common stock sold have not been registered under the Securities Act of 1933, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: - 22 - EXHIBIT NO. EXHIBIT DESCRIPTION ----------- ------------------- 3.1 Articles of Incorporation are incorporated by reference to exhibit 3.1 of the Company's Registration Statement on Form SB-2 (Commission File No. 333-63769) that became effective on December 17, 1998. 3.2 Bylaws of the Company are incorporated by reference to exhibit 3.2 of the Company's Registration Statement on Form SB-2 (Commission File No. 333-63769) that became effective on December 17, 1998. 3.3 First Amendment to the Bylaws of the Company dated December 19, 2001 is incorporated by reference to exhibit 3.3 of the Company's March 31, 2002 10QSB. 10.1 First Amendment to Community Shores Bank Corporation Floating Rate Subordintated Note due June 30, 2007 and Subordinated Note Purchase Agreement between Community Shores Bank Corporation and John L. Hilt, acting through his IRA, dated August 28, 2002. 10.2 First Amendment to Community Shores Bank Corporation Floating Rate Subordintated Note due June 30, 2007 and Subordinated Note Purchase Agreement between Community Shores Bank Corporation and Donald E. Hegedus dated August 28, 2002. 10.3 First Amendment to Community Shores Bank Corporation Floating Rate Subordintated Note due June 30, 2007 and Subordinated Note Purchase Agreement between Community Shores Bank Corporation and Michael D. Gluhanich dated August 28, 2002. 10.4 First Amendment to Community Shores Bank Corporation Floating Rate Subordintated Note due June 30, 2007 and Subordinated Note Purchase Agreement between Community Shores Bank Corporation and Robert L. Chandonnet dated August 28, 2002. 10.5 First Amendment to Community Shores Bank Corporation Floating Rate Subordintated Note due June 30, 2007 and Subordinated Note Purchase Agreement between Community Shores Bank Corporation and Community Shores LLC dated August 28, 2002. 99.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K. No reports on Form 8-K were filed during the quarter for which this report is filed. - 23 - SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 14, 2002. COMMUNITY SHORES BANK CORPORATION By: /s/ Jose' A. Infante -------------------------------------------- Jose' A. Infante Chairman of the Board, President and Chief Executive Officer (principal executive officer) By: /s/ Tracey A. Welsh -------------------------------------------- Tracey A. Welsh Chief Financial Officer and Vice President (principal financial and accounting officer) - 24 - CERTIFICATIONS I, Jose' A. Infante, Chairman, President and Chief Executive Officer of Community Shores Bank Corporation, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Community Shores Bank Corporation (the "registrant"); 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and - 25 - 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ Jose' A. Infante ------------------------------------------------ Jose' A. Infante Chairman, President and Chief Executive Officer - 26 - I, Tracey A. Welsh, Chief Financial Officer and Vice President of Community Shores Bank Corporation, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Community Shores Bank Corporation (the "registrant"); 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and - 27 - 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ Tracey A. Welsh ------------------------------------------- Tracey A. Welsh Chief Financial Officer and Vice President - 28 - EXHIBIT INDEX EXHIBIT NO. EXHIBIT DESCRIPTION ----------- ------------------- 3.1 Articles of Incorporation are incorporated by reference to exhibit 3.1 of the Company's Registration Statement on Form SB-2 (Commission File No. 333-63769) that became effective on December 17, 1998. 3.2 Bylaws of the Company are incorporated by reference to exhibit 3.2 of the Company's Registration Statement on Form SB-2 (Commission File No. 333-63769) that became effective on December 17, 1998. 3.3 First Amendment to the Bylaws of the Company dated December 19, 2001 is incorporated by reference to exhibit 3.3 of the Company's March 31, 2002 10QSB. 10.1 First Amendment to Community Shores Bank Corporation Floating Rate Subordintated Note due June 30, 2007 and Subordinated Note Purchase Agreement between Community Shores Bank Corporation and John L. Hilt, acting through his IRA, dated August 28, 2002. 10.2 First Amendment to Community Shores Bank Corporation Floating Rate Subordintated Note due June 30, 2007 and Subordinated Note Purchase Agreement between Community Shores Bank Corporation and Donald E. Hegedus dated August 28, 2002. 10.3 First Amendment to Community Shores Bank Corporation Floating Rate Subordintated Note due June 30, 2007 and Subordinated Note Purchase Agreement between Community Shores Bank Corporation and Michael D. Gluhanich dated August 28, 2002. 10.4 First Amendment to Community Shores Bank Corporation Floating Rate Subordintated Note due June 30, 2007 and Subordinated Note Purchase Agreement between Community Shores Bank Corporation and Robert L. Chandonnet dated August 28, 2002. 10.5 First Amendment to Community Shores Bank Corporation Floating Rate Subordintated Note due June 30, 2007 and Subordinated Note Purchase Agreement between Community Shores Bank Corporation and Community Shores LLC dated August 28, 2002. 99.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. - 29 -