10QSB 1 k10035e10qsb.txt QUARTERLY REPORT FOR PERIOD ENDED SEPTEMBER 30, 2006 U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-QSB [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2006 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________. Commission File No. 333-63769 COMMUNITY SHORES BANK CORPORATION (Exact name of small business issuer as specified in its charter) Michigan 38-3423227 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.)
1030 W. NORTON AVENUE, MUSKEGON, MICHIGAN 49441 (Address of principal executive offices) (231) 780-1800 (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark whether the registrant is a shell company as defined by Rule 12-b2 of the Exchange Act). Yes No X ----- ----- At October 31, 2006, 1,466,800 shares of Common Stock of the issuer were outstanding. Transitional Small Business Disclosure Format: Yes No X ----- ----- Community Shores Bank Corporation Index
Page No. -------- PART I. Financial Information Item 1. Financial Statements................................ 1 Item 2. Management's Discussion and Analysis................ 16 Item 3. Controls and Procedures............................. 28 PART II. Other Information Item 1. Legal Proceedings................................... 28 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds............................................ 28 Item 3. Defaults upon Senior Securities..................... 28 Item 4. Submission of Matters to a Vote of Security Holders............................................. 28 Item 5. Other Information................................... 29 Item 6. Exhibits............................................ 29 Signatures.................................................. 30
PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) COMMUNITY SHORES BANK CORPORATION CONSOLIDATED BALANCE SHEETS (UNAUDITED)
September 30, December 31, 2006 2005 ------------- ------------ (unaudited) ASSETS Cash and due from financial institutions $ 4,134,507 $ 4,361,277 Interest-bearing deposits in other financial institutions 54,455 90,182 Federal funds sold 450,000 200,000 ------------ ------------ Cash and cash equivalents 4,638,962 4,651,459 Securities Available for sale (at fair value) 13,096,118 13,983,933 Held to maturity (fair value of $5,222,999 at September 30, 2006 and $4,822,327 at December 31, 2005) 5,261,103 4,918,499 ------------ ------------ Total securities 18,357,221 18,902,432 Loans 205,040,775 192,644,742 Less: Allowance for loan losses 2,546,827 2,612,581 ------------ ------------ Net loans 202,493,948 190,032,161 Federal Home Loan Bank stock 411,500 425,000 Premises and equipment, net 8,431,199 5,922,886 Accrued interest receivable 1,105,749 994,219 Other assets 2,938,675 1,238,194 ------------ ------------ Total assets $238,377,254 $222,166,351 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Deposits Non-interest bearing $ 17,810,068 $ 16,564,735 Interest bearing 187,645,924 173,886,366 ------------ ------------ Total deposits 205,455,992 190,451,101 Federal funds purchased and repurchase agreements 5,026,652 6,065,010 Federal Home Loan Bank advances 6,000,000 6,000,000 Subordinated debentures 4,500,000 4,500,000 Notes Payable 400,000 0 Accrued expenses and other liabilities 1,126,753 650,329 ------------ ------------ Total liabilities 222,509,397 207,666,440 Shareholders' equity Common stock, no par value; 9,000,000 shares authorized; September 30, 2006 1,466,800 and December 31, 2005 1,436,800 shares issued 13,274,098 12,998,670 Retained Earnings 2,781,193 1,712,462 Accumulated other comprehensive loss (187,434) (211,221) ------------ ------------ Total shareholders' equity 15,867,857 14,499,911 ------------ ------------ Total liabilities and shareholders' equity $238,377,254 $222,166,351 ============ ============
See accompanying notes to consolidated financial statements. -1- COMMUNITY SHORES BANK CORPORATION CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Three Months Nine Months Nine Months Ended Ended Ended Ended September September September September 30, 2006 30, 2005 30, 2006 30, 2005 ------------ ------------ ----------- ----------- Interest and dividend income Loans, including fees $4,098,809 $3,334,559 $11,468,639 $9,255,802 Securities and FHLB dividends 181,241 181,576 541,281 512,293 Federal funds sold and other income 7,095 39,953 126,834 57,225 ---------- ---------- ----------- ---------- Total interest income 4,287,145 3,556,088 12,136,754 9,825,320 Interest expense Deposits 1,833,631 1,260,477 5,050,865 3,171,853 Repurchase agreements, federal funds purchased, and other debt 107,957 43,535 218,640 171,988 Federal Home Loan Bank advances and notes payable 181,588 151,781 515,328 434,889 ---------- ---------- ----------- ---------- Total interest expense 2,123,176 1,455,793 5,784,833 3,778,730 ---------- ---------- ----------- ---------- NET INTEREST INCOME 2,163,969 2,100,295 6,351,921 6,046,590 Provision for loan losses 216,873 98,300 518,625 346,057 ---------- ---------- ----------- ---------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,947,096 2,001,995 5,833,296 5,700,533 Noninterest income Service charges on deposit accounts 239,155 236,699 733,444 670,202 Mortgage loan referral fees 0 5,752 1,437 7,872 Net gain on sale of loans 124,610 3,717 141,013 20,152 Net gain (loss) on disposition of equipment 0 11,578 (124) 11,925 Other 97,015 72,336 261,250 225,552 ---------- ---------- ----------- ---------- Total noninterest income 460,780 330,082 1,137,020 935,703 Noninterest expense Salaries and employee benefits 992,048 991,226 2,930,124 2,740,725 Occupancy 100,828 83,086 275,902 231,484 Furniture and equipment 113,069 105,501 311,323 285,395 Advertising 90,778 32,058 174,570 118,485 Data processing 93,185 86,884 289,463 265,622 Professional services 166,603 131,219 424,394 396,528 Other 329,173 336,927 1,026,462 965,572 ---------- ---------- ----------- ---------- Total noninterest expense 1,885,684 1,766,901 5,432,238 5,003,811 ---------- ---------- ----------- ---------- INCOME BEFORE FEDERAL INCOME TAXES 522,192 565,176 1,538,078 1,632,425 Federal income tax expense 159,045 175,860 469,347 538,457 ---------- ---------- ----------- ---------- NET INCOME $ 363,147 $ 389,316 $ 1,068,731 $1,093,968 ========== ========== =========== ========== Comprehensive income $ 496,307 $ 341,104 $ 1,092,518 $ 969,791 ========== ========== =========== ========== Weighted average shares outstanding 1,449,191 1,435,757 1,440,976 1,433,304 ========== ========== =========== ========== Diluted average shares outstanding 1,476,893 1,480,317 1,471,044 1,468,214 ========== ========== =========== ========== Basic earnings per share $ 0.25 $ 0.27 $ 0.74 $ 0.76 ========== ========== =========== ========== Diluted earnings per share $ 0.25 $ 0.26 $ 0.73 $ 0.75 ========== ========== =========== ==========
See accompanying notes to consolidated financial statements. -2- COMMUNITY SHORES BANK CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
Accumulated Other Total Common Retained Comprehensive Shareholders' Shares Stock Earnings Income (Loss) Equity --------- ----------- ---------- ------------- ------------- BALANCE AT JANUARY 1, 2005 1,430,000 $12,922,314 $ 499,783 $ (22,763) $13,399,334 Proceeds from the exercise of stock options 6,800 69,604 69,604 Comprehensive income: Net Income 1,093,968 1,093,968 Unrealized loss on securities available-for-sale, net (124,177) (124,177) ----------- Total comprehensive income 0 969,791 --------- ----------- ---------- --------- ----------- BALANCE, SEPTEMBER 30, 2005 1,436,800 $12,991,918 $1,593,751 $(146,940) $14,438,729 ========= =========== ========== ========= =========== BALANCE AT JANUARY 1, 2006 1,436,800 $12,998,670 $1,712,462 $(211,221) $14,499,911 Proceeds from the exercise of stock options 40,000 400,000 400,000 Stock tendered for option exercises (10,000) (125,900) (125,900) Stock option compensation expense 1,328 1,328 Comprehensive income: Net income 1,068,731 1,068,731 Unrealized gain (loss) on securities available-for-sale, net 23,787 23,787 ----------- Total comprehensive income 1,092,518 --------- ----------- ---------- --------- ----------- BALANCE AT SEPTEMBER 30, 2006 1,466,800 $13,274,098 $2,781,193 $(187,434) $15,867,857 ========= =========== ========== ========= ===========
See accompanying notes to consolidated financial statements. -3- COMMUNITY SHORES BANK CORPORATION CONSOLIDATED STATEMENTS OF CASHFLOW (UNAUDITED)
Nine Months Nine Months Ended Ended September 30, 2006 September 30, 2005 ------------------ ------------------ CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 1,068,731 $ 1,093,968 Adjustments to reconcile net income to net cash from operating activities Provision for loan losses 518,625 346,057 Depreciation and amortization 217,331 221,589 Net amortization of securities 21,357 24,604 Net realized gain on sale of loans (141,013) (20,152) Net realized gain (loss) on disposition of equipment 124 (11,925) Stock option compensation expense 1,328 0 Loans originated for sale (2,766,245) (2,569,050) Proceeds from loan sales 2,907,257 2,589,202 Net change in: Accrued interest receivable and other assets (1,824,265) (195,991) Accrued expenses and other liabilities 476,424 146,619 ------------- ------------- Net cash from operating activities 479,654 1,624,921 CASH FLOWS FROM INVESTING ACTIVITIES Activity in available-for-sale securities: Maturities, prepayments and calls 2,159,546 1,756,322 Purchases (1,247,388) 0 Activity in held-to-maturity securities Maturities 185,000 105,000 Purchases (537,262) (4,153,795) Loan originations and payments, net (12,980,412) (16,002,745) Redemption of Federal Home Loan Bank stock 13,500 0 Net additions to premises and equipment (2,725,768) (2,284,148) ------------- ------------- Net cash used in investing activities (15,132,784) (20,579,366) CASH FLOW FROM FINANCING ACTIVITIES Net change in deposits 15,004,891 27,260,770 Net change in federal funds purchased and repurchase agreements (1,038,358) (3,085,062) Draw on note payable 600,000 0 Paydown on note payable (200,000) 0 Net proceeds from the exercise of stock options 274,100 69,604 ------------- ------------- Net cash from financing activities 14,640,633 24,245,312 ------------- ------------- Net change in cash and cash equivalents (12,497) 5,290,867 Beginning cash and cash equivalents 4,651,459 2,375,615 ------------- ------------- ENDING CASH AND CASH EQUIVALENTS $ 4,638,962 $ 7,666,482 ============= ============= Supplemental cash flow information: Cash paid during the period for Interest $ 5,599,930 $ 3,740,107 Cash paid for federal income tax $ 340,000 $ 735,000
See accompanying notes to consolidated financial statements. -4- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION: The unaudited, consolidated financial statements as of and for the three months and nine months ended September 30, 2006 include the consolidated results of operations of Community Shores Bank Corporation ("Company") and its wholly-owned subsidiaries, Community Shores Bank ("Bank") and Community Shores Financial Services, and a wholly-owned subsidiary of the Bank, Community Shores Mortgage Company ("Mortgage Company"). These consolidated financial statements have been prepared in accordance with the instructions for Form 10-QSB and Item 310(b) of Regulation S-B and do not include all disclosures required by generally accepted accounting principles for a complete presentation of the Company's financial condition and results of operations. In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair representation of the results of operations for such periods. The results for the period ended September 30, 2006 should not be considered as indicative of results for a full year. For further information, refer to the consolidated financial statements and footnotes included in the Company's annual report on Form 10-KSB for the period ended December 31, 2005. Some items in the prior year financial statements were reclassified to conform to the current presentation. In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109 (FIN 48), which clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements in accordance with SFAS 109, Accounting for Income Taxes. FIN 48 prescribes a recognition and measurement threshold for a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company has not completed its evaluation of the impact of the adoption of FIN 48. In September 2006, the Securities and Exchange Commission released Staff Accounting Bulletin (SAB) 108. This SAB provides detailed guidance to registrants in the determination of what is material to their financial statements. This SAB is required to be applied to financial statements issued after November 15, 2006. Upon adoption, the cumulative effect of applying the new guidance is to be reflected as an adjustment to opening retained earnings as of the beginning of the current fiscal year. The Company has not completed its evaluation of the impact of SAB 108. 2. STOCK COMPENSATION Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standard No. 123(R), Accounting for Stock-Based Compensation ("123(R)"), and has included the stock-based employee compensation expense in its income statement for the nine months ended September 30, 2006. Prior periods have not been restated. -5- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 2. STOCK COMPENSATION (Continued) Options to buy stock were granted to officers under the Company's 1998 Employee Stock Option Plan ("the 1998 Employee Plan"), which provided for issue of options for up to 150,000 shares of stock of the Company. The 1998 Employee Plan expired on September 1, 2003. While active, the 1998 Employee Plan stipulated an exercise price of no less than the market price at the date of grant and vesting over three years. On May 12, 2005, the shareholders approved both the 2005 Employee Stock Option Plan ("the 2005 Employee Plan") and the 2005 Director Stock Option Plan ("the 2005 Director Plan"). Details of the individual plans are included in the table below.
2005 Employee Plan 2005 Director Plan ---------------------------------------------- ---------------------------------------------- Shares authorized 53,000 20,000 Qualification as incentive plan Yes No Option Price Not less than fair market value on the date of Not less than fair market value on the date of grant grant Vesting period 25% immediately and 25% on the next three Immediate anniversaries (as determined by the Board of Directors) Expiration Up to 10 years from grant date Up to 10 years from grant date
On December 12, 2005, the Director Stock Option Committee of the Board of Directors granted options for 2,000 shares to each of the nine non-employee directors on the Company's Board. Each option has an exercise price of $14.54 per share, which was the fair market value of the Company's common stock as of the grant date. There are options for 2,000 shares left to be granted. As of September 30, 2006, no awards have been issued under the 2005 Employee Plan. Upon exercise of stock options, the Company issues new shares from its authorized but unissued shares. There was no vesting activity during the quarter as all issued options were vested by June 30, 2006. Activity in issued but unvested options year to date was as follows:
Weighted Avg Shares Exercise Price ------ -------------- Issued and unvested as of December 31, 2005 281 $10.28 Shares vested during the period (281) 10.28 ---- ------ Issued and unvested as of September 30, 2006 0 0.00
The fair value of options vested in the first nine months of 2006 was $1,328. -6- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 2. STOCK COMPENSATION (Continued) The fair value was computed using the following assumptions, which were determined as of the grant date:
2003 ------ Risk-free interest rate 3.61% Expected option life 7 yrs Expected stock price volatility 36.22% Dividend yield 0.00% Computed fair value per share $ 4.72
Compensation costs for all option plans were as follows:
Three months ended Nine months ended September 30, September 30, ------------------ ----------------- 2006 2005 2006 2005 ---- ---- ---- ---- Compensation cost recognized in income $0 $0 $1,328 $0 Related tax benefit recognized 0 0 0 0
Below is the activity under all plans for the three and nine month periods ended September 30, 2006:
Three months ended September 30, 2006 Total options outstanding ---------------------------- Wtd Avg Wtd Avg Exercise Fair Shares Price Value ------- -------- ------- Options outstanding, beginning of period 155,775 $10.55 $ 3.65 Forfeited 0 0 0 Exercised 40,000 $10.00 $ 2.76 Granted 0 0 0 ------- ------ ------ Options outstanding, end of period 115,775 $10.74 $ 3.92 Options exercisable, end of period 115,775 $10.74 $ 3.92
Nine months ended September 30, 2006 Total options outstanding ---------------------------- Wtd Avg Wtd Avg Exercise Fair Shares Price Value ------- -------- ------- Options outstanding, beginning of period 155,775 $10.55 $3.65 Forfeited 0 0 0 Exercised 40,000 $10.00 $2.76 Granted 0 0 0 ------- ------ ----- Options outstanding, end of period 115,775 $10.74 $3.92 Options exercisable, end of period 115,775 $10.74 $3.92
The intrinsic value of options outstanding and options exercisable at September 30, 2006 was $199,130. -7- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 2. STOCK COMPENSATION (Continued) The following table illustrates the effect on net income and earnings per share for the three month and nine month periods ending September 30, 2005 if expense had been measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation. The 2006 results are already inclusive of FASB Statement No. 123.
Three months ended Nine months ended September 30, September 30, ------------------- ----------------------- 2006 2005 2006 2005 -------- -------- ---------- ---------- Net income as reported $363,147 $389,316 $1,068,731 $1,093,968 Less: Value determined under fair value based method (net of taxes) 0 2,311 1,328 6,933 Amount expensed in the period (net of taxes) 0 0 (1,328) 0 -------- -------- ---------- ---------- Pro forma net income $363,147 $387,005 $1,068,731 $1,087,035 ======== ======== ========== ========== Basic earnings per share as reported $ 0.25 $ 0.27 $ 0.74 $ 0.76 Pro forma basic earnings per share $ 0.25 $ 0.27 $ 0.74 $ 0.76 Diluted earnings per share as reported $ 0.25 $ 0.26 $ 0.73 $ 0.75 Pro forma diluted earnings per share $ 0.25 $ 0.26 $ 0.73 $ 0.74
3. SECURITIES The following tables represent the securities held in the Company's portfolio at September 30, 2006 and at December 31, 2005:
Gross Gross Amortized Unrealized Unrealized Fair September 30, 2006 Cost Gains Losses Value % ------------------ ---------- ---------- ---------- ----------- ---- Available for sale: US Government and federal agency $7,459 $(111,455) $ 4,919,124 26.8 Municipal securities 4,890 (4,605) 706,771 3.8 Mortgage-backed securities 5,869 (186,149) 7,470,223 40.7 ------- --------- ----------- ---- $18,218 $(302,209) $13,096,118 71.3 Held to maturity: Municipal securities $5,261,103 $ 6,161 $ (44,265) $ 5,222,999 28.7
Gross Gross Amortized Unrealized Unrealized Fair December 31, 2005 Cost Gains Losses Value % ------------------ ---------- ---------- ---------- ----------- ---- Available for sale: US Government and federal agency $ 0 $(166,450) $ 5,360,898 28.4 Municipal securities 6,009 (7,928) 706,641 3.7 Mortgage-backed securities 5,953 (157,616) 7,916,394 41.9 ------- --------- ----------- ---- 11,962 (331,994) 13,983,933 74.0 Held to maturity: Municipal securities $4,918,499 2,327 (98,499) 4,822,327 26.0
-8- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 3. SECURITIES (Continued) Below is the schedule of maturities for investments held at September 30, 2006:
Held to Maturity ----------------------- Available for Sale Amortized Fair Fair Value Cost Value ------------------ ---------- ---------- Due in one year or less $ 2,844,260 $ 0 $ 0 Due from one to five years 2,660,769 928,681 924,279 Due in more than five years 120,866 4,332,422 4,298,720 Mortgage-backed 7,470,223 0 0 ----------- ---------- ---------- $13,096,118 $5,261,103 $5,222,999 =========== ========== ==========
4. LOANS The components of the outstanding balances, their percentage of the total portfolio and the percentage increase from the end of 2005 to September 30, 2006 were as follows:
Percent September 30, 2006 December 31, 2005 Increase/ Balance % Balance % (Decrease) ------------ ----- ------------ ----- ---------- Commercial $ 89,486,083 43.6% $ 85,883,914 44.6% 4.19% Real Estate: Commercial 76,651,117 37.4 68,445,169 35.5 11.99 Residential 9,945,784 4.9 9,366,098 4.9 6.19 Construction 1,520,152 0.7 1,636,526 0.8 (7.11) Consumer 27,581,916 13.4 27,445,727 14.2 0.50 ------------ ----- ------------ ----- Gross loans 205,185,052 100.0 192,777,434 100.0 6.43 ===== ===== Less: allowance for loan losses (2,546,827) (2,612,581) Net deferred loan fees (144,277) (132,692) ------------ ------------ Net loans $202,493,948 $190,032,161 ============ ============
-9- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 5. ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS The following is a summary of activity in the allowance for loan losses account for the three and nine month periods ended September 30, 2006 and 2005:
Three Months Three Months Nine Months Nine Months Ended Ended Ended Ended 09/30/06 09/30/05 09/30/06 09/30/05 ------------ ------------ ----------- ----------- Beginning Balance $2,436,765 $2,154,519 $2,612,581 $2,039,198 Charge-offs Commercial (80,130) (21,616) (460,737) (85,166) Real estate-commercial -- -- -- -- Real estate-residential -- -- -- -- Real estate-construction -- -- -- -- Consumer (31,834) (40,704) (176,214) (137,401) ---------- ---------- ---------- ---------- Total Charge-offs (111,964) (62,320) (636,951) (222,567) Recoveries Commercial 1,607 -- 9,527 -- Real estate-commercial -- -- -- -- Real estate-residential -- -- -- -- Real estate-construction -- -- -- -- Consumer 3,546 3,623 43,045 31,434 ---------- ---------- ---------- ---------- Total Recoveries 5,153 3,623 52,572 31,434 Provision for loan losses 216,873 98,300 518,625 346,057 ---------- ---------- ---------- ---------- Ending Balance $2,546,827 $2,194,122 $2,546,827 $2,194,122 ========== ========== ========== ==========
6. PREMISES AND EQUIPMENT Period end premises and equipment were as follows:
September 30, December 31, 2006 2005 ------------- ------------ Land & land improvements $ 3,744,028 $3,744,028 Buildings & building improvements 1,693,410 1,689,664 Furniture, fixtures and equipment 2,046,905 2,245,604 Construction in Process 2,902,054 273,738 ----------- ---------- 10,386,397 7,953,034 Less: accumulated depreciation 1,955,198 2,030,148 ----------- ---------- $ 8,431,199 $5,922,886 =========== ==========
-10- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 7. DEPOSITS Deposit balances increased $15,004,891 since December 31, 2005. The components of the outstanding balances, their percentage of the total portfolio and the percentage increase from the end of 2005 through September 30, 2006 were as follows:
September 30, 2006 December 31, 2005 Percent -------------------- -------------------- Increase/ Balance % Balance % (Decrease) ------------ ----- ------------ ----- ---------- Non-interest bearing Demand $ 17,810,068 8.7% $ 16,564,735 8.7% 7.5% Interest bearing Checking 21,145,622 10.3 23,465,273 12.3 (9.9) Money Market 19,023,100 9.3 17,408,588 9.1 9.3 Savings 12,613,135 6.1 14,432,484 7.6 (12.6) Time, under $100,000 35,396,413 17.2 28,922,830 15.2 22.4 Time, over $100,000 99,467,654 48.4 89,657,191 47.1 10.9 ------------ ----- ------------ ----- Total Deposits $205,455,992 100.0% $190,451,101 100.0% ============ ===== ============ =====
8. SHORT-TERM BORROWINGS At both September 30, 2006 and December 31, 2005, the Company's short-term borrowings were made up of repurchase agreements only. The September 30, 2006 and December 31, 2005 information was as follows:
Repurchase Federal Funds Agreements Purchased ----------- ------------- Outstanding at September 30, 2006 $ 5,026,652 $ 0 Average interest rate at period end 3.35% 0.00% Average balance during period 4,908,560 2,580,385 Average interest rate during period 3.08% 5.44% Maximum month end balance during period 5,205,503 6,700,000 Outstanding at December 31, 2005 $ 6,065,010 $ 0 Average interest rate at year end 2.83% 0.00% Average balance during year 7,757,732 3,157,507 Average interest rate during year 1.88% 3.42% Maximum month end balance during year 10,776,372 10,600,000
-11- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 9. FEDERAL HOME LOAN BANK BORROWINGS The Bank was approved in the first quarter of 1999 to be a member of the Federal Home Loan Bank of Indianapolis. Based on its current Federal Home Loan Bank Stock holdings, the Bank has the capacity to borrow $7,003,440. Each borrowing requires a direct pledge of securities or loans. At September 30, 2006, the Bank had assets with a market value of $9,711,257 pledged to the Federal Home Loan Bank to support current borrowings. Details of the Bank's outstanding borrowings at both September 30, 2006 and December 31, 2005 are:
Current September 30, December 31, Maturity Date Interest Rate 2006 2005 ------------- ------------- ------------- ------------ March 24, 2010 5.99 1,500,000 1,500,000 November 3, 2010 5.95 2,000,000 2,000,000 December 13, 2010 5.10 2,500,000 2,500,000 ---------- ---------- $6,000,000 $6,000,000
10. SUBORDINATED DEBENTURES The subordinated debentures stemmed from a trust preferred security offering. Community Shores Capital Trust I ("the Trust"), a business trust formed by the Company, sold 4,500 Cumulative Preferred Securities ("trust preferred securities") at $1,000 per security in a December 2004 offering. The proceeds from the sale of the trust preferred securities were used by the Trust to purchase an equivalent amount of subordinated debentures from the Company. The trust preferred securities carry a floating rate of 2.05% over the 3-month LIBOR. This was initially set at 4.55125% and was 7.421630% at September 28, 2006. The stated maturity is December 30, 2034. The securities are redeemable at par on any interest payment date on or after December 30, 2009 with regulatory approval, if then required, and are, in effect, guaranteed by the Company. Distributions on the trust preferred securities are payable quarterly on or about March 30th, June 30th, September 30th and December 30th. The most recent distribution was paid on October 2, 2006, which was the first business day following September 30, 2006. Under certain circumstances, distributions may be deferred up to 20 calendar quarters. However, during any such deferrals, interest accrues on any unpaid distributions at a floating rate of 2.05% over the 3-month LIBOR. 11. NOTES PAYABLE The Company has a $5 million revolving line of credit with LaSalle Bank National Association ("LaSalle"). The total balance outstanding at September 30, 2006 was $400,000. There was no balance on the line at December 31, 2005. The Company made three draws of $200,000 during the first nine months of the year, one in each quarter. During the third quarter, the Company made a payment of $200,000 using proceeds received from employee stock option exercises. The outstanding principal bears interest at a rate of 90 basis points below LaSalle's prime rate, which is currently 8.25%. Interest is owed quarterly in arrears on the first business day of February, May, August, and November until the principal of this note is paid. The borrowings may be -12- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 11. NOTES PAYABLE (Continued) prepaid in whole or in part without any prepayment penalty. The proceeds were essentially used for the general operating expenses of the Company. 12. COMMITMENTS AND OFF-BALANCE SHEET RISK Some financial instruments are used to meet financing needs and to reduce exposure to interest rate changes. These financial instruments include commitments to extend credit and standby letters of credit. These involve, to varying degrees, credit and interest-rate risk in excess of the amount reported in the financial statements. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment, and generally have fixed expiration dates. Standby letters of credit are conditional commitments to guarantee a customer's performance to another party. Exposure to credit loss if the customer does not perform is represented by the contractual amount for commitments to extend credit and standby letters of credit. Collateral or other security is normally obtained for these financial instruments prior to their use, and many of the commitments are expected to expire without being used. A summary of the notional and contractual amounts of outstanding financing instruments with off-balance-sheet risk as of September 30, 2006 and December 31, 2005 follows:
September 30, December 31, 2006 2005 ------------- ------------ Unused lines of credit and letters of credit $38,261,604 $37,923,303 Commitments to make loans 62,300 271,127
Commitments to make loans generally terminate one year or less from the date of commitment and may require a fee. Since many of the above commitments on lines of credit and letters of credits expire without being used, the above amounts related to those categories do not necessarily represent future cash commitments. 13. REGULATORY MATTERS The Company and Bank are subject to regulatory capital requirements administered by the federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall -13- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 13. REGULATORY MATTERS (Continued) financial condition. If adequately capitalized, regulator approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required. The required capital to risk-weighted assets and tier one capital to average asset ratios for the first three capital classifications are as follows:
Capital to risk weighted assets ----------------- Tier 1 Capital Total Tier 1 to average assets ----- ------ ----------------- Well capitalized 10% 6% 5% Adequately capitalized 8 4 4 Undercapitalized 6 3 3
Actual capital levels and minimum required levels at September 30, 2006 and December 31, 2005 for the Company and Bank were:
Minimum Required to Be Well Capitalized Minimum Required Under Prompt For Capital Corrective Action Actual Adequacy Purposes Provisions ------------------- ------------------- ------------------- Amount Ratio Amount Ratio Amount Ratio ----------- ----- ----------- ----- ----------- ----- September 30. 2006 Total Capital (Tier 1 and Tier 2) to risk-weighted assets Consolidated $23,102,118 10.46% $17,675,448 8.00% $22,094,310 N/A Bank 23,171,183 10.49 17,671,970 8.00 22,089,963 10.00 Tier 1 (Core) Capital to risk risk-weighted assets Consolidated 20,555,291 9.30 8,837,724 4.00 13,262,586 N/A Bank 20,624,356 9.34 8,835,985 4.00 13,253,978 6.00 Tier 1 (Core) Capital to average assets Consolidated 20,555,291 8.81 9,335,982 4.00 11,669,977 N/A Bank 20,624,356 8.84 9,334,210 4.00 11,667,763 5.00 December 31. 2005 Total Capital (Tier 1 and Tier 2) to risk weighted assets Consolidated $21,746,410 10.73% $16,231,964 8.00% $20,289,955 N/A Bank 21,683,639 10.70 16,230,267 8.00 20,287,834 10.00 Tier 1 (Core) Capital to risk risk-weighted assets Consolidated 19,211,132 9.48 8,115,982 4.00 12,173,973 N/A Bank 19,148,629 9.44 8,115,134 4.00 12,172,700 6.00 Tier 1 (Core) Capital to average assets Consolidated 19,211,132 8.73 8,802,457 4.00 11,003,072 N/A Bank 19,148,629 8.70 8,801,143 4.00 11,001,429 5.00
-14- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 13. REGULATORY MATTERS (Continued) The Company and the Bank were in the well-capitalized category at both September 30, 2006 and December 31, 2005. The Company is closely monitoring the Bank's growth and for the foreseeable future expects to infuse additional capital as necessary to maintain at least a 10% (well capitalized) total capital to risk weighted assets ratio for the Bank. See further discussion in the Financial Condition section of the Management Discussion and Analysis concerning the Company's sources for future capital contributions to the Bank. -15- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS The discussion below details the financial results of the Company and its wholly owned subsidiaries, the Bank and Community Shores Financial Services, and the Bank's subsidiary, the Mortgage Company, through September 30, 2006 and is separated into two parts which are labeled, Financial Condition and Results of Operations. The part labeled Financial Condition compares the financial condition at September 30, 2006 to that at December 31, 2005. The part labeled Results of Operations discusses the three month and nine month periods ended September 30, 2006 as compared to the same periods of 2005. Both parts should be read in conjunction with the interim consolidated financial statements and footnotes included in Item 1 of this Form 10-QSB. This discussion and analysis and other sections of this Form 10-QSB contain forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about the Company, the Bank, the Mortgage Company and Community Shores Financial Services. Words such as "anticipates", "believes", "estimates", "expects", "forecasts", "intends", "is likely", "plans", "projects", variations of such words and similar expressions are intended to identify such forward-looking statements. These forward-looking statements are intended to be covered by the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("Future Factors") that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. The Company undertakes no obligation to update, amend, or clarify forward looking statements, whether as a result of new information, future events (whether anticipated or unanticipated), or otherwise. Future Factors include, among others, changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulation; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; changes in the national and local economy; and other factors, including risk factors, referred to from time to time in filings made by the Company with the Securities and Exchange Commission. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement. FINANCIAL CONDITION Total assets increased by $16.2 million to $238.4 million at September 30, 2006 from $222.2 million at December 31, 2005. This is a 7.3% increase in assets during the first nine months of 2006. Asset growth was funded by deposit growth and was mostly reflected by increases in the loan portfolio and premises and equipment. -16- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS Total loans climbed to $205.0 million at September 30, 2006 from $192.6 million at December 31, 2005. The $12.4 million net increase is primarily comprised of $11.8 million growth in the commercial and commercial real estate portfolios. The "wholesale" (commercial and commercial real estate) lending focus applied since opening in 1999 continued during the first nine months of 2006. Presently, the commercial and commercial real estate categories of loans comprise 81% of the Bank's total loan portfolio. There are eight experienced commercial lenders on staff devoted to pursuing and originating these types of loans. Since year-end 2005 two lenders have left the Bank to work for a local competitor. As a result of the turnover, it is a possibility that the Bank may lose some customers. To reduce the risk, the Bank has identified a list of potentially vulnerable relationships and spent a significant amount of time visiting those customers. In the third quarter, one new lender was recruited to replace one of the open lending positions. It is the Bank's intention to retain existing lending staff and attract another new lender to fill the remaining position created by the turnover. The Company attempts to mitigate interest rate risk in its loan portfolio in many ways. The main approach is to balance the rate sensitivity of the portfolio and manage extension risk(1). The loan maturities and rate sensitivity of the loan portfolio at September 30, 2006 are included below:
Within Three to One to After Three Twelve Five Five Months Months Years Years Total ----------- ----------- ------------ ----------- ------------ Commercial, financial and other $21,130,481 $29,683,339 $ 34,651,643 $ 3,876,343 $ 89,341,806 Real estate: Commercial 9,112,198 8,434,896 57,806,632 1,297,391 76,651,117 Residential 65,011 218,023 1,348,056 8,314,694 9,945,784 Construction 1,036,038 484,114 -- -- 1,520,152 Installment loans to individuals 2,120,206 3,723,224 19,811,653 1,926,833 27,581,916 ----------- ----------- ------------ ----------- ------------ $33,463,934 $42,543,596 $113,617,984 $15,415,261 $205,040,775 =========== =========== ============ =========== ============ Loans at fixed rates $ 5,648,935 $ 5,357,854 $ 85,016,133 $10,249,277 $106,272,199 Loans at variable rates 27,814,999 37,185,742 28,601,851 5,165,984 98,768,576 ----------- ----------- ------------ ----------- ------------ $33,463,934 $42,543,596 $113,617,984 $15,415,261 $205,040,775 =========== =========== ============ =========== ============
At September 30, 2006, 52% of the loan balances carried a fixed rate, 48% a floating rate and only 7.5% of the entire portfolio had a contractual maturity longer than five years. The loan portfolio is reviewed and analyzed on a regular basis for the purpose of estimating probable incurred credit losses. The allowance for loan losses is adjusted accordingly to maintain an adequate level based on that analysis given the risk characteristics of the loan portfolio. At September 30, 2006, the allowance totaled $2.5 million or approximately 1.24% of gross loans outstanding. Management has determined that this is an appropriate level based on its detailed review of the loan portfolio using a consistent methodology involving loan ratings, delinquency trends, historical loss experience as well as current economic conditions. ---------- (1) Extension risk, as related to loans, exists when booking fixed rate loans with long final contractual maturities. When a customer is contractually allowed longer to return their borrowed principal and rates rise, the Bank is delayed from taking advantage of the opportunity to reinvest the returning principal at the higher market rate. -17- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS Based on management's analysis, an additional $519,000 was added to the allowance through provision for loan losses during the first nine months of 2006 with $217,000 being added in the third quarter. The allocation of the allowance at September 30, 2006 was as follows:
September 30, 2006 December 31, 2005 -------------------------- --------------------------- Percent of Percent of Allowance Allowance Balance at End of Period Applicable to: Related to Related to Amount Loan category Amount Loan category ---------- ------------- ---------- -------------- Commercial $1,260,749 49.5% $1,460,911 55.9% Real estate: Commercial 915,029 35.9 777,331 29.8 Residential 49,729 2.0 46,830 1.8 Construction 17,482 0.7 18,820 0.7 Consumer 303,838 11.9 308,689 11.8 Unallocated 0 0.0 0 0.0 ---------- ----- ---------- ----- Total $2,546,827 100.0% $2,612,581 100.0% ========== ===== ========== =====
The ratio of allowance for loan losses to total loans declined from a level of 1.36% at December 31, 2005 in spite of the net growth in the commercial and commercial real estate loan portfolios. The main factor in the reduction was that there were charge-offs totaling $637,000 in the first nine months of 2006. Seventy five percent of the total principal charged off was related to one commercial relationship. The allowance for loan losses at December 31, 2005 contained significant specific allocations for this relationship, increasing the percent of allowance related to the commercial loan category and driving up the overall ratio of allowance for loan losses to total loans at year-end. Once the charge offs occurred, the percent of the allowance related to the commercial loan category declined and so did the overall ratio of allowance for loan losses to total loans. Conversely, there has been a significant increase in the allowance allocated to commercial real estate loans. A majority of the increase stems from the fact that 66% of the loan growth since December 31, 2005 has been in the commercial real estate category. Another factor considered in the assessment of the adequacy of the allowance is the quality of the loan portfolio from a past due standpoint. Below is a table, which details the past due balances at September 30, 2006 compared to those at year-end 2005 and the corresponding change, related to those two periods.
September 30, December 31, Increase Loans Past Due: 2006 2005 (Decrease) --------------- ------------- ------------ ----------- 30-59 days $972,000 $2,423,000 ($1,451,000) 60-89 days 314,000 159,000 155,000 90 days and greater 620,000 379,000 241,000 Non accrual notes 774,000 749,000 25,000
Since year-end 2005, overall past due and non-accrual loans have decreased by $1.0 million. A majority of the decrease occurred in the 30-59 day category. The elevated sum of loans in -18- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS this past due category at year-end was caused by a multiplicity of minor factors. Most of the improvement shown above had taken place by January 31, 2006. Contrary to the decline in the 30-59 day past due category, loans past due 60-89 days increased between the two period ends. One relationship totaling 38% of total loans past due 60-89 days is in the process of selling the underlying real estate collateral and expects to pay the Bank off sometime in November. There is minimal loss expected as a result of the transaction. On November 1, 2006, another relationship comprising 24% of total loans past due 60-89 days, developed a plan with the Bank's collection department to bring the loan balances current prior to year-end. Approximately 45% of the total loans past due 90 days and more is related to one commercial credit. This customer was not past due at year-end 2005. The customer is involved in the farming industry. At this time, the Bank has initiated the foreclosure process. No significant losses are expected. The balances outstanding are well collateralized by real estate. Non-accrual loans increased minimally, $25,000, since December 31, 2005. Although the collection process is believed to be sound, there was still the need to charge-off loans. Annualized net charge-offs to average loans was 0.40% for the first nine months of 2006, up significantly from 0.14% for the first nine months of 2005. There were net charge-offs of $584,000 recorded for the first nine months of 2006, which is higher than net charge-offs of $191,000 for the similar period in 2005. Approximately 66% of the net charge-offs recorded in 2006 occurred in the first quarter. Over 61% of year to date charge-offs are related to one commercial relationship. Premises and equipment increased by a net figure of $2.5 million. The majority of the increase is related to construction of two branches in the Muskegon area. Both branches are scheduled to open in the next four months. The Bank is also in the process of finalizing plans for construction of a branch in Grand Haven on US 31. The construction is expected to begin in the fall and to be completed by August 2007. The current Grand Haven banking location is leased. Finally, the Bank purchased vacant land at Apple and Quarterline on the east side of Muskegon on October 5, 2006. The purchase price was $721,000. Other Assets rose by $1.7 million. A majority (68%) of the increase was a receivable from an investor that had purchased a Small Business Administration (SBA) loan prior to September 30 but had not yet remitted the proceeds. The proceeds were received on October 3,2006. Deposit balances were $205.5 million at September 30, 2006 up from $190.5 million at December 31, 2005. Total deposit growth since year-end was $15.0 million or 7.9%. The entire increase is made up of growth in time deposits. Time deposits rose $16.3 million since year-end 2005. Time deposit totals include both local and brokered deposits. Local time deposit balances grew $7.4 million in the first nine months of 2006. This achievement is the result of consistently advertised rate specials conducted locally in the newspaper and in the branches. Brokered deposits made up 55% of the growth in time deposits during the first three quarters of the year. Brokered deposits are time deposits obtained from depositors located outside of the Bank's market area and are placed with the Bank by a deposit broker. The concentration of -19- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS brokered deposits to local deposits has increased to 36% at September 30, 2006 from 35% at December 31, 2005. It is anticipated that the usage of brokered deposits will taper over time once the branch network of the Bank expands. The Bank had Federal Home Loan Bank ("FHLB") advances outstanding, totaling $6,000,000, at both September 30, 2006 and December 31, 2005. The advances consist of three separate notes, which are all putable advances. All three instruments currently have rates ranging from 5.10% to 5.99%. All three notes are eligible to convert to a floating rate index at the option of the FHLB (put option). The option is contractually available to the FHLB once each quarter. If the option is exercised, the advance will convert to a floating rate based on a spread to LIBOR. In the event that the FHLB exercises its option and the note is converted, the Bank has the opportunity to repay the advance at that time with no pre-payment penalty. As borrowing rates continue to climb, it is a possibility that the FHLB will exercise the put. The applicable LIBOR rates are monitored every quarter by management to assess the likelihood of the FHLB converting any of the three notes. Based on the most recent assessment, the Bank believes that there may be a basis for expecting the FHLB to exercise its put for one of the advances on the next call date, which is December 2006. The principal balance outstanding on this particular advance is $2.5 million. The scheduled maturities, if the notes are not paid prior to that, are all in 2010. At both September 30, 2006 and December 31, 2005, the Company had $4.5 million of subordinated debentures outstanding resulting from a pooled trust preferred offering on December 17, 2004. The notes payable balance consists of draws on the Company's revolving line of credit with LaSalle. The balance increased $400,000 since December 31, 2005. In each of the first three quarters of 2006, the Company made a $200,000 draw. In August, the bank received cash from an employee stock option exercise and remitted $200,000 to LaSalle to pay down principal. The proceeds in all cases were used for general operating expenses of the Company. Future draws are expected for similar reasons as well as for the purpose of contributing capital to the Bank to maintain a regulatory well-capitalized status. The shareholders' equity totaled $15.9 million and $14.5 million at September 30, 2006 and December 31, 2005 respectively. The increase is comprised of increases to common stock as a result of a stock option exercise, earnings recorded in the first nine months of 2006 and a reduction of accumulated other comprehensive loss (security market value adjustments). RESULTS OF OPERATIONS The net income for the first nine months of 2006 was $1,069,000 a decrease of $25,000 compared to net income of $1,094,000 recorded for the same time period in 2005. The corresponding basic and diluted earnings per share for the first nine months of 2006 were $0.74 and $0.73 respectively, and $0.76 and $0.75 for 2005. Net income for the third quarter of 2006 was $363,000 while net income for the similar period in 2005 was $389,000. The corresponding basic and diluted earnings per share for the third -20- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS quarter of 2006 was $0.25 which is slightly less than the basic earnings and diluted earnings per share of $0.27 and $0.26 recorded for the same period in 2005. For both the first nine months and third quarter of 2006, the annualized return on the Company's average total assets was 0.62%, which is down from 0.69% and 0.71% annualized return for the same periods in 2005. The Company's annualized return on average equity was 9.42% and 9.33% for the first nine months and third quarter of 2006 and 10.50% and 10.89% for the first nine months and third quarter of 2005. The ratio of average equity to average assets was 6.60% and 6.67% for the first nine months and third quarter of 2006 and 6.59% and 6.49% for the same periods in 2005. Although the net earnings are similar for the third quarter and first nine months of 2006 compared to the same periods in 2005, there are important differences in the various categories of income and expense. One difference between the operating results of the first nine months of 2005 and 2006 is the net interest income and the corresponding net interest margin. The following table sets forth certain information relating to the Company's consolidated average interest earning assets and interest bearing liabilities and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing annualized income or expenses by the average daily balance of assets or liabilities, respectively, for the periods presented. -21- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS
Nine months ended September 30: -------------------------------------------------------------------------------- 2006 2005 --------------------------------------- -------------------------------------- Average Average Average Average Balance Interest Yield/Rate Balance Interest Yield/Rate ------------ ----------- ---------- ------------ ---------- ---------- Assets Federal funds sold and interest- bearing deposits with banks $ 3,720,311 $ 126,834 4.55% $ 2,509,265 $ 57,225 3.04% Securities (including FHLB stock)(1) 19,430,919 621,798 4.27 18,522,144 555,022 4.00 Loans (2) 196,017,819 11,468,639 7.80 182,507,263 9,255,802 6.76 ------------ ----------- ------ ------------ ---------- ------ 219,169,049 12,217,271 7.43 203,538,672 9,868,049 6.46 Other assets 10,198,478 7,122,464 ------------ ------------ $229,367,527 $210,661,136 ============ ============ Liabilities and Shareholders' Equity Interest bearing deposits $177,886,277 $ 5,050,865 3.79 $158,217,454 $3,171,853 2.67 Federal funds purchased and repurchase agreements 7,488,944 218,640 3.89 11,194,854 171,988 2.05 Note Payable and Federal Home Loan Bank Advances 10,704,396 515,328 6.42 10,500,000 434,889 5.52 ------------ ----------- ------ ------------ ---------- ------ 196,079,617 5,784,833 3.93 179,912,308 3,778,730 2.80 ----------- ---------- Non-interest bearing deposits 17,564,795 16,074,574 Other liabilities 589,265 781,330 Shareholders' Equity 15,133,850 13,892,924 ------------ ------------ $229,367,527 $210,661,136 ============ ============ Net interest income (tax equivalent basis) 6,432,438 6,089,319 Net interest spread on earning assets (tax equivalent basis) 3.50% 3.66% ====== ====== Net interest margin on earning assets (tax equivalent basis) 3.91% 3.99% ====== ====== Average interest-earning assets to Average interest-bearing liabilities 111.78% 113.13% ====== ====== Tax equivalent adjustment 80,517 42,729 ----------- ---------- Net interest income $ 6,351,921 $6,046,590 =========== ==========
The tax equivalent net interest spread on average earning assets decreased 16 basis points to 3.50% since September 30, 2005. The tax equivalent net interest margin decreased by 8 basis points from 3.99% at September 30, 2005 to 3.91% at September 30, 2006. The tax equivalent net interest income for the first nine months of 2006 was $6.4 million compared to a figure of $6.0 million for the same nine months in 2005. Although the Company reported more total net interest income there was net interest margin compression between the two periods. Relative increases to loan income from higher internal prime lending rates and more average loans outstanding were not as much as the increases in expense experienced on the funding side from a rate and outstanding balance perspective. The average rate earned on interest earning assets was 7.43% for the nine months ended September 30, 2006 compared to 6.46% for the same period in 2005, a 97 basis point increase. The main contributing factor was a 104 basis point increase in the yield on loans, the Bank's largest earning asset category. Internal prime rate changes, no matter what direction, ---------- (1) Adjusted to fully tax equivalent basis. (2) Includes loans held for sale and non-accrual loans. -22- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS affect interest earned on variable rate loans and new loan volume. At September 30, 2006, 48% of the Bank's loan portfolio was variable compared to 60% at September 30, 2005. A lower concentration of variable rate loans means that less loans on the books were able to take advantage of the 193 basis point increase in the average internal prime lending rate between the two periods. Interest expense incurred on deposits, repurchase agreements, federal funds purchased, Federal Home Loan Bank advances and Notes Payable increased by 113 basis points for the first nine months of 2006 compared to the first nine months of 2005. During 2005, there was a significant lag between the timing of loan rate increases and increases in the Bank's cost of funds. For the first nine months of 2006, funding rates rose at a faster pace than increases to the rates on earning assets. In fact, since December 2005, the average rate on cost of funds rose 97 basis points or 16 basis points more than the increase on earning assets. Management believes that stabilization of the prime lending rate could cause further net interest margin compression since it is likely that deposit rates would continue to rise for a period of time. The quarter-to-quarter comparison of consolidated average interest earning assets and interest bearing liabilities and average yield on assets and average cost of liabilities for the third quarter ended September 30, 2006 and 2005 is in the table below. -23- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS
Three months ended September 30: ------------------------------------------------------------------------------- 2006 2005 -------------------------------------- -------------------------------------- Average Average Average Average Balance Interest Yield/Rate Balance Interest Yield/Rate ------------ ---------- ---------- ------------ ---------- ---------- Assets Federal funds sold and interest- bearing deposits with banks $ 566,559 $ 7,095 5.01% $ 4,787,602 $ 39,953 3.34% Securities (including FHLB stock)(1) 19,201,745 208,480 4.34 19,750,698 205,065 4.15 Loans (2) 202,431,823 4,098,809 8.10 187,909,232 3,334,559 7.10 ------------ ---------- ------ ------------ ---------- ------ 222,200,127 4,314,384 7.77 212,447,532 3,579,577 6.74 Other assets 11,199,417 7,653,475 ------------ ------------ $233,399,544 $220,101,007 ============ ============ Liabilities and Shareholders' Equity Interest bearing deposits $178,115,917 $1,833,631 4.12 $168,883,952 $1,260,477 2.99 Federal funds purchased and repurchase agreements 9,636,852 107,957 4.48 7,688,902 43,535 2.26 Note Payable and Federal Home Loan Bank Advances 10,828,261 181,588 6.71 10,500,000 151,781 5.78 ------------ ---------- ------ ------------ ---------- ------ 198,581,030 2,123,176 4.28 187,072,854 1,455,793 3.11 ---------- ---------- Non-interest bearing deposits 18,377,412 17,780,466 Other liabilities 872,117 957,733 Shareholders' Equity 15,568,985 14,289,954 ------------ ------------ $233,399,544 $220,101,007 ============ ============ Net interest income (tax equivalent basis) 2,191,208 2,123,784 Net interest spread on earning assets (tax equivalent basis) 3.49% 3.63% ====== ====== Net interest margin on earning assets (tax equivalent basis) 3.94% 4.00% ====== ====== Average interest-earning assets to Average interest-bearing liabilities 111.89% 113.56% ====== ====== Tax equivalent adjustment 27,239 23,489 ---------- ---------- Net interest income $2,163,969 $2,100,295 ========== ==========
Similar to the comparison of the net interest income results of the first nine months of 2005 to that of the first nine months of 2006, there was an overall increase in tax equivalent net interest income between the two three month periods but there was net interest margin compression. Tax equivalent net interest income improved by $67,000 but the tax equivalent net interest spread and margin declined by 14 and 6 basis points respectively between the third quarter of 2005 and the similar period in 2006. There was a 183 basis point difference in the internal prime lending rate between the two periods. Since escalating cost of funds appear probable and future prime rate changes, no matter what direction, are unpredictable, asset liability management will continue to be an important tool for assessing and monitoring interest rate sensitivity and liquidity. Management of interest rate sensitivity attempts to avoid widely varying net interest margins and achieve consistent net interest income through periods of changing interest rates. Asset liability management assists the Company in realizing reasonable and predictable earnings and liquidity by maintaining a balance between interest-earning assets and interest-bearing liabilities. Liquidity management ---------- (1) Adjusted to fully tax equivalent basis. (2) Includes loans held for sale and non-accrual loans. -24- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS involves the ability to meet the cash flow requirements of the Company's customers. These customers may be either borrowers with credit needs or depositors wanting to withdraw funds. The Company uses a sophisticated computer program to assist with asset liability management, model and measure interest rate sensitivity and perform analysis of interest rate risk. Interest rate sensitivity varies with different types of earning assets and interest-bearing liabilities. Overnight investments, on which rates change daily, and loans tied to the prime rate, differ considerably from long term investment securities and fixed rate loans. Interest bearing checking and money market accounts are more interest sensitive than long term time deposits and fixed rate FHLB advances. Comparison of the repricing intervals of interest earning assets to interest bearing liabilities is a measure of interest sensitivity gap. Balancing this gap is a continual challenge in a changing rate environment. Details of the repricing gap at September 30, 2006 were:
Interest Rate Sensitivity Period ---------------------------------------------------------------------- Within Three to One to After Three Twelve Five Five Months Months Years Years Total ------------ ------------ ----------- ----------- ------------ Earning assets Interest-bearing deposits In other financial institutions $ 54,455 $ 0 $ 0 $ 0 $ 54,455 Federal funds sold 450,000 0 0 0 450,000 Securities (including FHLB stock) 2,339,203 2,568,895 9,021,632 4,838,991 18,768,721 Loans (including held for sale) 105,743,940 12,384,883 80,482,536 6,429,416 205,040,775 ------------ ------------ ----------- ----------- ------------ 108,587,598 14,953,778 89,504,168 11,268,407 224,313,951 Interest-bearing liabilities Savings and checking 52,781,859 0 0 0 52,781,859 Time deposits <$100,000 6,456,424 21,121,415 7,793,573 25,000 35,396,412 Time deposits >$100,000 9,979,485 42,523,687 46,964,481 0 99,467,653 Repurchase agreements and Federal funds purchased 5,026,652 0 0 0 5,026,652 Notes payable and Federal Home Loan bank advances 10,900,000 0 0 0 10,900,000 ------------ ------------ ----------- ----------- ------------ 85,144,420 63,645,102 54,758,054 25,000 203,572,576 Net asset (liability) repricing gap $ 23,443,178 $(48,691,324) $34,746,114 $11,243,407 $ 20,741,375 ============ ============ =========== =========== ============ Cumulative net asset (liability) Repricing gap $ 23,443,178 $(25,248,146) $ 9,497,968 $20,741,375 ============ ============ =========== ===========
Currently the Company has a negative twelve month repricing gap which indicates that the Company is liability sensitive in the next twelve month period. This position implies that increases to the national federal funds rate would have more of an impact on interest expense than on interest income during this period if there were a parallel shift in rates. For instance if the Company's internal prime rate went up by 25 basis points and every interest earning asset and interest bearing liability on the Company's September 30, 2006 balance sheet repricing in the next twelve months adjusted simultaneously by the same 25 basis points, more liabilities would be affected than assets. At this point in time it would not be prudent to assume that deposit rates will only increase if the national federal funds rate increases. The local marketplace has experienced significant increases in deposit rates as noted above. The interest rate sensitivity table simply illustrates what the Company is contractually able to change in certain timeframes. -25- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS The provision for loan losses for the third quarter and the first nine months of 2006 were $217,000 and $519,000 compared to figures of $98,000 and $346,000 for the same periods in 2005. 2005's expenses included a credit rating upgrade of a significant commercial loan customer. This event allowed the removal of specifically allocated reserves previously assigned to the loan. As a result, in 2005, the Bank was able to use the unallocated reserve to support a portion of new loan growth. So although loan growth was similar in the first nine months of 2005 and 2006 the credit upgrade made the provision expense required between the two periods look significantly different. Management believes that the allowance level is adequate and justified based on the factors discussed earlier (see Financial Condition). Management will continue to review the allowance with the intent of maintaining it at an appropriate level. The provision may be increased or decreased in the future as management continues to monitor the loan portfolio and actual loan loss experience. Non-interest income recorded in the first nine months of 2006 totaled $1.1 million and represented a 22% increase over last year's first nine month total, which was $936,000. There were two primary factors responsible for the rise, service charge income and gains on loan sales. The service charge income was $63,000 higher in the first nine months of 2006 compared to the similar period in 2005. Non-sufficient funds charges related to the Overdraft Privilege program increased $91,000 but were offset by a decline in business account service charges. Gains on loan sales totaled $141,000 in the first nine months of 2006 compared to $20,000 recorded for the similar period in 2005. Late last year, the Bank recruited an experienced SBA lender to develop an active SBA lending program. In the third quarter of 2006, the Bank implemented its SBA lending program and was able to originate and sell two loans to various investors for a realized gain of $121,000. The program as designed entails originating SBA loans and selling the guaranteed portion(usually 75%-80%) to an investor for a premium. The Bank intends on retaining the unguaranteed portion of each sold loan and will receive a monthly servicing fee for processing the loan payments. Management is optimistic about the SBA lending program and its continued contributions to non-interest income. Total non-interest income for the third quarter of 2006 rose $131,000 over that which was recorded in the third quarter of 2005. The gains on loan sales described above comprised 92% of the increase. Non-interest expenses for the first nine months of 2006 were $5.4 million compared to a total of $5.0 million for 2005, an increase of 9%. The third quarter non-interest expense total was $1.9 million for 2006 and $1.8 million for 2005. Salaries and benefits for the third quarter of 2006 were essentially flat when compared to the similar period in 2005. Conversely, the year to date totals for salaries and benefits did increase by 6.9% to $2.9 million. On average there were an additional 5.0 full-time equivalent employees between the same nine month period in 2006 and that of 2005. These additions as well as general salary increases resulted in an increased expense of $189,000. Some of the additions to staff were for the Harvey Street Branch, which is scheduled to open on November 6, 2006. The increase in salaries and benefits between the first nine months of 2006 and the similar period in 2005 accounted for 44% of the increase in total non-interest expenses. -26- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS Occupancy expenses were $276,000 for the first three quarters of 2006 compared to $231,000 for the first three quarters of 2005. The increase of $44,000 was attributable to expenses associated with getting out of our North Muskegon lease early as well as higher property tax liabilities resulting from land purchases in Norton Shores, North Muskegon and Grand Haven during 2005. The Bank intends to operate a new full service branch at each of these sites. The Grand Haven and North Muskegon branches are replacements of the spaces that are currently leased. Each branch is in various stages of construction. As the branches become functional the occupancy expenses are expected to increase from the additional depreciation costs. Advertising expenses of $175,000 were recorded for the first nine months of 2006 compared to $118,000 for the same period one year ago. The increase of $57,000 (48%) was mostly attributable to an enhanced marketing campaign. All of the year to date increase was recorded in the third quarter. Advertising costs in the third quarter of 2006 were $59,000 more than those recorded in 2005's third quarter. Advertising costs are likely to escalate given the fact that there are three branches scheduled to open in the next twelve months. Professional services expenses were $167,000 for the third quarter of 2006, which was an increase of $35,000 (27%) compared to the third quarter of 2005. The increase is primarily related to legal fees associated with a matter addressed late in the second quarter. The line item showing other non-interest expenses for the first nine months of 2006 has increased $61,000 (6%) compared to the same period in 2005. The most significant item supporting the increase was an upsurge in loan collection expenses of $75,000 between the two periods. A substantial portion of the increase is related to one impaired commercial relationship and the related expenses incurred to liquidate the associated collateral. The federal tax expense has decreased for both the third quarter and first nine months of 2006 compared to the same periods in 2005. The decreases are related to differences in tax free municipal bond holdings between the two period ends. The effective tax rate for the first nine months and third quarter of 2006 was 31% and 30% compared to 33% and 31% for the first nine months and third quarter of 2005. -27- COMMUNITY SHORES BANK CORPORATION ITEM 3. CONTROLS AND PROCEDURES An evaluation was carried out under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of September 30, 2006. Based on the evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures were, to the best of their knowledge, effective as of September 30, 2006 with respect to information required to be disclosed by the Company in reports that it files or submits under the Exchange Act. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time, the Company, the Bank, the Mortgage Company or Community Shores Financial Services may be involved in various legal proceedings that are incidental to their business. In the opinion of management, the Company, the Bank, the Mortgage Company and Community Shores Financial Services are not a party to any current legal proceedings that are material to their financial condition, either individually or in the aggregate. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS On August 24, 2006, the Company issued and sold 40,000 shares of its common stock to a past employee upon his exercise of a stock option issued to him under the Company's 1998 Employee Stock Option Plan. The Company received an exercise price of $10.00 per share. The $400,000 exercise price for these shares was paid by the employee delivering to the Company $274,100 in cash, and 10,000 shares of common stock of the Company that he already owned having an aggregate value of $125,900. The 40,000 shares issued upon exercise of the stock option were sold in reliance on an exemption from registration under the Securities Act of 1933, based on Section 4(2) of that Act, and Regulation D issued under that Act. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. -28- COMMUNITY SHORES BANK CORPORATION ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS
EXHIBIT NO. EXHIBIT DESCRIPTION ----------- ------------------- 3.1 Articles of Incorporation of the Company are incorporated by reference to exhibit 3.1 of the Company's June 30, 2004 Form 10-QSB (SEC file number 333-63769). 3.2 Bylaws of the Company are incorporated by reference to exhibit 3(ii) of the Company's June 28, 2006 Form 8-K (SEC file number 000-51166). 10.1 Extension to the agreement between Fiserv Solutions, Inc. and Community Shores Bank is incorporated by reference to exhibit 10.2 of the Company's July 7, 2006 Form 8-K (SEC File No. 000-51166). 10.2 Addendum #3 to the Buy and Sell Agreement with Baumgardner-Hogan Real Estate, LLC is incorporated by reference to exhibit 10.1 of the Company's July 11, 2006 Form 8-K (SEC File No. 000-51166). 31.1 Rule 13a-14(a) Certification of the principal executive officer. 31.2 Rule 13a-14(a) Certification of the principal financial officer. 32.1 Section 1350 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Section 1350 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
-29- SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 14, 2006. COMMUNITY SHORES BANK CORPORATION By: /s/ Heather D Brolick ------------------------------------- Heather D. Brolick President and Chief Executive Officer (principal executive officer) By: /s/ Tracey A. Welsh ------------------------------------- Tracey A. Welsh Senior Vice President, Chief Financial Officer and Treasurer (principal financial and accounting officer) -30- EXHIBIT INDEX
EXHIBIT NO. EXHIBIT DESCRIPTION ----------- ------------------- 3.1 Articles of Incorporation of the Company are incorporated by reference to exhibit 3.1 of the Company's June 30, 2004 Form 10-QSB (SEC file number 333-63769). 3.2 Bylaws of the Company are incorporated by reference to exhibit 3(ii) of the Company's June 28, 2006 Form 8-K (SEC file number 000-51166). 10.1 Extension to the agreement between Fiserv Solutions, Inc. and Community Shores Bank is incorporated by reference to exhibit 10.2 of the Company's July 7, 2006 Form 8-K (SEC File No. 000-51166). 10.2 Addendum #3 to the Buy and Sell Agreement with Baumgardner-Hogan Real Estate, LLC is incorporated by reference to exhibit 10.1 of the Company's July 11, 2006 Form 8-K (SEC File No. 000-51166). 31.1 Rule 13a-14(a) Certification of the principal executive officer. 31.2 Rule 13a-14(a) Certification of the principal financial officer. 32.1 Section 1350 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Section 1350 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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