-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Rzt7T5AD0rZRwnz4fj7C5EK1+U6HfT9l4sBJkyDvrSGU9h4G0jD39CvaHtdlSN5t yb/R86ALj2mr56QeQhUxIQ== 0000950124-07-001953.txt : 20070402 0000950124-07-001953.hdr.sgml : 20070402 20070402150441 ACCESSION NUMBER: 0000950124-07-001953 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20061231 FILED AS OF DATE: 20070402 DATE AS OF CHANGE: 20070402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COMMUNITY SHORES BANK CORP CENTRAL INDEX KEY: 0001070523 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 383423227 STATE OF INCORPORATION: MI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-51166 FILM NUMBER: 07738172 BUSINESS ADDRESS: STREET 1: 1030 W. NORTON AVENUE CITY: MUSKEGON STATE: MI ZIP: 49441 BUSINESS PHONE: 2317801800 MAIL ADDRESS: STREET 1: 1030 W. NORTON AVENUE CITY: MUSKEGON STATE: MI ZIP: 49441 10KSB 1 k13450e10ksb.txt ANNUAL REPORT OF SMALL BUSINESS DATED DECEMBER 31, 2006 U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------ FORM 10-KSB [X] Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2006 Commission File No. 000-51166 COMMUNITY SHORES BANK CORPORATION (Name of small business issuer in its charter) MICHIGAN 38-3423227 (State or other jurisdiction (IRS Employer of incorporation or organization) Identification No.) 1030 W. NORTON AVENUE, MUSKEGON, MICHIGAN 49441 (Address of principal executive offices) (zip code) (231) 780-1800 (Issuer's telephone number) Securities registered under Section 12(b) of the Exchange Act: Title of each class Name of each exchange on which registered Common Stock The Nasdaq Stock Market LLC ------------ --------------------------- Securities registered under Section 12(g) of the Exchange Act: None Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. [ ] Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X] Issuer's revenue for its most recent fiscal year was approximately $18,007,000. The aggregate market value of voting stock of the registrant held by nonaffiliates was approximately $18,955,000 as of February 28, 2007; based on the average of the closing bid and ask prices ($12.905) on that date. As of March 15, 2007, 1,468,800 shares of Common Stock of the issuer were outstanding. DOCUMENTS INCORPORATED BY REFERENCE: Parts I and II Portions of 2006 Annual Report to the Shareholders of the issuer. Part III Portions of the Proxy Statement of the issuer for its May 10, 2007 Annual Meeting Transitional Small Business Disclosure Format YES [ ] NO [X] PART I ITEM 1. DESCRIPTION OF BUSINESS GENERAL Community Shores Bank Corporation ("the Company"), organized in 1998, is a Michigan corporation and a bank holding company. The Company owns all of the common stock of Community Shores Bank (the "Bank"). The Bank was organized and commenced operations in January, 1999 as a Michigan chartered bank with depository accounts insured by the FDIC to the extent permitted by law. The Bank provides a full range of commercial and consumer banking services primarily in the communities of Muskegon County and Northern Ottawa County. The Bank's services include checking and savings accounts, certificates of deposit, safe deposit boxes, courier service, and loans for commercial and consumer purposes. Community Shores Mortgage Company (the "Mortgage Company") was incorporated on December 13, 2001. The Mortgage Company, a wholly owned subsidiary of the Bank, originates both commercial and residential real estate loans. Most fixed rate residential real estate loans originated are sold to a third party. Commercial and residential real estate loans that are held in the Mortgage Company's portfolio are serviced by the Bank pursuant to a servicing agreement. On September 27, 2002, pursuant to Title I of the Gramm-Leach-Bliley Act, the Company received regulatory approval to become a financial holding company. After becoming a financial holding company the Company created Community Shores Financial Services ("CS Financial Services"). Currently the only source of revenue that CS Financial Services receives is referral fee income from a local insurance agency, Lakeshore Employee Benefits, formerly Lead Financial. Lakeshore Employee Benefits offers, among other things, employer sponsored benefit plans. CS Financial Services has the opportunity to earn a referral fee for each sale of employer sponsored benefits that is transacted by Lakeshore Employee Benefits as a result of a referral made by CS Financial Services. In December of 2004, the Company formed Community Shores Capital Trust I, a Delaware business trust. The Trust is administered by a Delaware trust company, and three individual administrative trustees who are employees and officers of the Company. The Trust was established for the purpose of issuing and selling its preferred securities and common securities and used the proceeds from the sales of those securities to acquire subordinated debentures issued by the Company. A majority of the net proceeds received by the Company was used to pay down the outstanding balance on the Company's line of credit. The remaining proceeds were used to contribute capital to the Bank as well as support the general operating expenses of the Company including the debt service on the Company's subordinated debentures. As of year-end 2006, the Company had total consolidated assets of $247 million. In 2006, the Company achieved its sixth fully profitable year of operations earning $0.89 per diluted share. Year over year earnings per share increased 8.5%. Improvements in the Company's net interest income as well as profits from loan sales positively impacted the bottom line. The Bank's average earning assets grew 7.6% during 2006, which helped improve the Company's net interest income. The increases in gains on loan sales were derived mainly from the sale of Small Business Administration ("SBA")-affiliated loans. Late in 2005, the Bank hired an experienced SBA lender to develop an SBA lending program. The gains are attributed to the sale of the guaranteed portion of floating rate SBA loans originated by the Bank. As a result of our dynamic approach to this business line, the Bank is considered Muskegon's leading SBA lender(1), surpassing the efforts of many large banks in our market. In November 2006, the Bank opened its fourth banking facility located in Norton Shores on Harvey Street. - ----------------- (1) According to the 2006 statistics compiled by the United States Small Business Administration. 2 The Company's main office is located at 1030 W. Norton Avenue, Muskegon, Michigan, 49441 and its telephone number is (231) 780-1800. PRODUCTS AND SERVICES The Bank offers a broad range of deposit services, including checking accounts, savings accounts and time deposits of various types. Transaction accounts and time certificates are tailored to the principal market area at rates competitive with those offered in the area. All qualified deposit accounts are insured by the FDIC up to the maximum amount permitted by law. The Bank solicits these accounts from individuals, businesses, schools, associations, churches, nonprofit organizations, financial institutions and government authorities. The Bank also uses alternative funding sources as needed, including advances from the Federal Home Loan Bank and obtaining deposits through a deposit broker. Additionally, the Bank makes available mutual funds and annuities, which are non-insured, through an alliance with Sorrento Pacific. Discount brokerage services are made available to our customers through Sorrento as well. The Bank receives referral fees for customers that open a brokerage account and conduct trades. Real Estate Loans. The Mortgage Company originates residential mortgage loans, which are generally long-term with either fixed or variable interest rates. The Mortgage Company's general policy, which is subject to review by management due to changing market and economic conditions and other factors, is to sell largely all fixed rate residential real estate loans on a servicing released basis in the secondary market, regardless of term or product. The Mortgage Company, based on its lending guidelines, may periodically elect to underwrite and retain certain mortgages in its portfolio. The Bank offers fixed rate home equity loans and variable rate home equity lines of credit, which are usually retained in its portfolio. The retention of variable rate loans in the Bank's loan portfolio helps to reduce the Bank's exposure to fluctuations in interest rates. However, such loans generally pose credit risks different from the risks inherent in fixed rate loans, primarily because as interest rates rise, the underlying payments from the borrowers rise, thereby increasing the potential for default. Personal Loans and Lines of Credit. The Bank makes personal loans and lines of credit available to consumers for various purposes, such as the purchase of automobiles, boats and other recreational vehicles, home improvements and personal investments. The Bank's current policy is to retain substantially all of these loans in its portfolio. Commercial and Commercial Real Estate Loans. Commercial loans are made primarily to small and mid-sized businesses. These loans are and will be both secured and unsecured and are made available for general operating purposes, acquisition of fixed assets including real estate, purchases of equipment and machinery, financing of inventory and accounts receivable, as well as any other purposes considered appropriate. Substantially all Commercial Real Estate Loan originations have been executed by the Mortgage Company, since March of 2002. The Bank and the Mortgage Company generally look to a borrower's business operations as the principal source of repayment, but will also receive, when appropriate, liens on real estate, security interests in inventory, accounts receivable and other personal property and/or personal guarantees. Although the Bank takes a progressive and competitive approach to lending, it stresses high quality in its loans. The Bank hires an independent company to perform loan review, to help monitor asset quality of the Bank. Any past due loans and identified problem loans are reviewed with the Board of Directors on a regular basis. Regulatory and supervisory loan-to-value limits are established pursuant to Section 304 of the Federal Deposit Insurance Corporation Improvement Act of 1991 "FDICIA" for loans secured by, or used to build on or improve, real estate. The Bank's internal limitations follow those limits and in certain cases are more restrictive than those required by the regulators. 3 The Bank has established relationships with correspondent banks and other independent financial institutions to provide other services requested by the Bank's customers, including loan participations where the requested loan amounts exceed the Bank's policies or legal lending limits. COMPETITION The Company's primary market area is Muskegon County and Northern Ottawa County. Northern Ottawa County primarily consists of the cities of Grand Haven, Ferrysburg, Spring Lake and the townships surrounding these areas. There are a number of banks, thrifts and credit union offices located in the Company's market area. Most are branches of larger financial institutions and are not 100% locally owned, with the exception of some credit unions. Competition with the Company also comes from other areas such as finance companies, insurance companies, mortgage companies, brokerage firms and other providers of financial services. Most of the Company's competitors have been in business a number of years longer than the Company and, for the most part, have established customer bases. The Company competes with these older institutions, through its ability to provide quality customer service, along with competitive products and services. EFFECT OF GOVERNMENT MONETARY POLICIES The earnings of the Company are affected by domestic economic conditions and the monetary and fiscal policies of the United States government, its agencies, and the Federal Reserve Board. The Federal Reserve Board's monetary policies have had, and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order to, among other things, curb inflation, maintain employment, and mitigate economic recession. The policies of the Federal Reserve Board have a major effect upon the levels of bank loans, investments and deposits through its open market operations in United States government securities, and through its regulation of, among other things, the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies. REGULATION AND SUPERVISION As a bank holding company under the Bank Holding Company Act, the Company is required to file an annual report with the Federal Reserve Board and such additional information as the Federal Reserve Board may require. The Company is also subject to examination by the Federal Reserve Board. The Bank Holding Company Act limits the activities of bank holding companies that have not qualified as financial holding companies to banking and the management of banking organizations, and to certain non-banking activities. These non-banking activities include those activities that the Federal Reserve Board found, by order or regulation as of the day prior to enactment of the Gramm-Leach-Bliley Act, to be so closely related to banking as to be a proper incident to banking. These non-banking activities include, among other things: operating a mortgage company, finance company, factoring company; performing certain data processing operations; providing certain investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, nonoperating basis; and providing discount securities brokerage services for customers. With the exception of the activities of the Mortgage Company and the third party arrangements with Lakeshore Employee Benefits and Sorrento Pacific discussed above, neither the Company nor any of its subsidiaries engages in any of the non-banking activities listed above. In September, 2002, the Company's election to become a financial holding company, as permitted by the Bank Holding Company Act, as amended by Title I of the Gramm-Leach-Bliley Act, was accepted by the Federal Reserve Board. In order to continue as a financial holding company, the Company and the Bank must satisfy statutory requirements regarding capitalization, management, and compliance with the Community 4 Reinvestment Act. As a financial holding company, the Company is permitted to engage in a broader range of activities than are permitted to bank holding companies which have not qualified as financial holding companies. Those expanded activities include any activity which the Federal Reserve Board (in certain instances in consultation with the Department of the Treasury) determines, by order or regulation, to be financial in nature or incidental to such financial activity, or to be complementary to a financial activity and not to pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. Such expanded activities include, among others: insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability or death, or issuing annuities, and acting as principal, agent, or broker for such purposes; providing financial, investment, or economic advisory services, including advising a mutual fund; and underwriting, dealing in, or making a market in securities. Other than the insurance agency activities of CS Financial Services, neither the Company nor its subsidiaries currently engages in any of the expanded activities. The Bank is subject to restrictions imposed by federal law and regulation. Among other things, these restrictions apply to any extension of credit to the Company or its other subsidiaries, to investments in stock or other securities issued by the Company, to the taking of such stock or securities as collateral for loans to any borrower, and to acquisitions of assets or services from, and sales of certain types of assets to, the Company or its other subsidiaries. Federal law restricts the ability of the Company or its other subsidiaries to borrow from the Bank by limiting the aggregate amount that may be borrowed and by requiring that all the loans be secured in designated amounts by specified forms of collateral. With respect to the acquisition of banking organizations, the Company is generally required to obtain the prior approval of the Federal Reserve Board before it can acquire all or substantially all of the assets of any bank, or acquire ownership or control of any voting shares of any bank or bank holding company, if, after the acquisition, the Company would own or control more than 5% of the voting shares of the bank or bank holding company. Acquisitions of banking organizations across state lines are subject to certain restrictions imposed by Federal and state law and regulations. LOAN POLICY The Bank makes loans primarily to individuals and businesses located within the Bank's market area. The loan policy of the Bank states that the function of the lending operation is to provide a means for the investment of funds at a profitable rate of return with an acceptable degree of risk, and to meet the credit needs of qualified businesses and individuals who become customers of the Bank. The Board of Directors of the Bank recognizes that, in the normal business of lending, some losses on loans will be inevitable. These losses will be carefully monitored and evaluated and are recognized as a normal cost of conducting business. The Bank's loan policy anticipates that priorities in extending loans will change from time to time as interest rates, market conditions and competitive factors change. The policy is designed to assist the Bank in managing the business risk involved in extending credit. It sets forth guidelines on a nondiscriminatory basis for lending in accordance with applicable laws and regulations. The policy describes criteria for evaluating a borrower's ability to support debt, including character of the borrower, evidence of financial responsibility, knowledge of collateral type, value and loan to value ratio, terms of repayment, source of repayment, payment history, and economic conditions. The Bank provides oversight and monitoring of lending practices and loan portfolio quality through the use of an Officers Loan Committee (the "Loan Committee"). The Loan Committee members include all commercial lenders, the Chief Lending Officer, the President, and other designated lending personnel. The Loan Committee is presently permitted to approve requests for loans in an amount not exceeding $2,000,000. The Loan Committee may recommend that requests exceeding this amount be approved by a committee of the Board of Directors (the "Executive Loan Committee") whose lending authority is approximately $2,750,000. Loan requests in excess of the Executive Loan Committee limit require the approval of the Board of Directors. The Board of Directors has the maximum lending authority permitted by law. However, generally, the loan policy establishes an "in house" limit slightly lower than the actual legal lending limit. The Bank's general legal 5 lending limit, as of December 31, 2006, was approximately $2,810,000, subject to a higher legal lending limit of approximately $4,683,000 in specific cases with approval by two-thirds of the Bank's Board of Directors. Under Michigan banking law, these amounts would change if the Bank's capital and surplus changed. In addition to the lending authority described above, the Bank's Board of Directors delegates significant authority to officers of the Bank. The Board believes this empowerment enables the Bank to be more responsive to its customers. The President of the Bank, the Chief Lending Officer of the Bank and the President of the Mortgage Company each have been delegated individual authority, where they deem it appropriate, to approve loans up to $1,000,000. Together, their delegated authority, where they deem it appropriate, is $2,000,000. Other officers have been delegated authority to approve loans of lesser amounts, where they deem it appropriate, without approval by the Loan Committee. The loan policy outlines the amount of funds that may be loaned against specific types of collateral. The loan to value ratios for first mortgages on residences are expected to comply with the guidelines of secondary market investors. First mortgages held within the Bank's portfolio are expected to mirror secondary market requirements. In those instances where loan to value ratio exceeds 80%, it is intended that private mortgage insurance will be obtained to minimize the Bank's risk. Loans secured by a second or junior lien generally will be limited to a loan to value ratio of 100%. Loans for improved residential real estate lots generally will not exceed a loan to value ratio of 80%, and loans for unimproved residential sites generally will not exceed a loan to value ratio of 75%. For certain loans secured by real estate, an appraisal of the property offered as collateral, by a state licensed or certified independent appraiser, will be required. The loan policy also provides general guidelines as to collateral, provides for environmental policy review, contains specific limitations with respect to loans to employees, executive officers and directors, provides for problem loan identification, establishes a policy for the maintenance of a loan loss reserve, provides for loan reviews and sets forth policies for mortgage lending and other matters relating to the Bank's lending practices. LENDING ACTIVITY Commercial Loans. The Bank's commercial lending group originates commercial loans primarily in the Western Michigan Counties of Muskegon and Northern Ottawa. Commercial loans are originated by experienced lenders under the leadership of the Chief Lending Officer. Loans are originated for general business purposes, including working capital, accounts receivable financing, machinery and equipment acquisition and commercial real estate financing, including new construction and land development. Working capital loans that are structured as a line of credit are reviewed periodically in connection with the borrower's year end financial reporting. These loans generally are secured by assets of the borrower and have an interest rate tied to the prime rate. Loans for machinery and equipment purposes typically have a maturity of five to seven years and are fully amortizing. Commercial real estate loans may have an interest rate that is fixed to maturity or floats with a spread to the prime rate or a U.S. Treasury Index. The Bank evaluates many aspects of a commercial loan transaction in order to minimize credit and interest rate risk. Underwriting commercial loans requires an assessment of management, products, markets, cash flow, capital, income and collateral. The analysis includes a review of historical and projected financial results. On certain transactions, where real estate is the primary collateral, and in some cases where equipment is the primary collateral, appraisals are obtained from licensed or certified appraisers. In certain situations, for creditworthy customers, the Bank may accept title reports instead of requiring lenders' policies of title insurance. Commercial real estate lending involves more risk than residential lending, because loan balances are greater and repayment is dependent upon the borrower's operations. The Bank attempts to minimize risk associated with these transactions by generally limiting its exposure to owner operated properties of well known customers or new customers with an established profitable history. In certain cases, risk may be further 6 reduced by (i) limiting the amount of credit to any one borrower to an amount less than the Bank's legal lending limit, and (ii) avoiding certain types of commercial real estate financing. Single Family Residential Real Estate Loans. The Bank originates first mortgage residential real estate loans in its market area according to secondary market underwriting standards. These loans are likely to provide borrowers with a fixed or adjustable interest rate with terms up to 30 years. A majority of the single family residential real estate loans are expected to be sold on a servicing released basis in the secondary market with all interest rate risk and credit risk passed to the purchaser. The Bank and the Mortgage Company may periodically elect to underwrite certain residential real estate loans, generally with maturities of seven years or less, to be held in its own loan portfolio. Consumer Loans. The Bank originates consumer loans for a variety of personal financial needs. Consumer loans are likely to include fixed home equity and equity lines of credit, new and used automobile loans, boat loans, personal unsecured lines of credit, credit cards (through third-party providers to minimize risk) and overdraft protection for checking account customers. Consumer loans generally have shorter terms and higher interest rates than residential mortgage loans and, except for home equity lines of credit, usually will involve greater credit risk due to the type and nature of the collateral securing the debt. Strong emphasis is placed on the amount of the down payment, credit quality, employment stability and monthly income. Hazard insurance is obtained (in favor of the Bank) on certain loan types, including automobiles and boats. Consumer loans are generally repaid on a monthly basis with the source of repayment tied to the borrower's periodic income. It is recognized that consumer loan delinquency and losses are dependent on the borrower's continuing financial stability. Job loss, illness and personal bankruptcy may adversely affect repayment. In many cases, repossessed collateral (on a secured consumer loan) may not be sufficient to satisfy the outstanding loan balance. This is a common occurrence due to depreciation of the underlying collateral. The Bank believes that the generally higher yields earned on consumer loans compensate for the increased credit risk associated with such loans. Consumer loans are expected to be an important component in the Bank's efforts to meet the credit needs of the communities and customers that it serves. LOAN PORTFOLIO QUALITY The Bank hires an independent firm to help management monitor and validate their ongoing assessment of the credit quality of the Bank's loan portfolio. The independent firm accomplishes this through a sampling of the loan portfolios for both commercial and retail loans. The independent firm also evaluates the loan underwriting, loan approval, loan monitoring, loan documentation, and problem loan administration practices of the Bank. The last loan review was performed in July 2006. The Bank is scheduled to undergo its next review in July of 2007. The Bank has a comprehensive loan grading system for commercial loans. Administered as part of the loan review program, all commercial loans are graded on a nine grade rating system utilizing a standardized grade paradigm that analyzes several critical factors, such as cash flow, management and collateral coverage. All commercial loans are graded at inception and at various intervals thereafter. All commercial loan relationships exceeding $500,000 are formally reviewed at least annually. Watch list credits are formally reviewed monthly. INVESTMENTS Bank Holding Company Investments. The principal investments of the Company are the investments in the common stock of the Bank and the common securities of the Trust. Other funds of the Company may be invested from time to time in various debt instruments. As a bank holding company, the Company is also permitted to make portfolio investments in equity securities and to make equity investments in subsidiaries engaged in a variety of non-banking activities, which include real estate-related activities such as community development, real estate appraisals, arranging equity financing 7 for commercial real estate, and owning and operating real estate used substantially by the Bank or acquired for its future use. In addition, the Company's qualification as a financial holding company enables it to make equity investments in companies engaged in a broader range of financial activities than the Company could do without that qualification. Such expanded activities include insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability or death, or issuing annuities, and acting as principal, agent, or broker for such purposes; providing financial, investment, or economic advisory services, including advising a mutual fund; and underwriting, dealing in, or making a market in securities. Other than its investment in CS Financial Services, the Company has no plans at this time to make directly any of these equity investments at the bank holding company level. The Company's Board of Directors may, however, alter the investment policy at any time without shareholder approval. In addition, so long as the Company is qualified as a financial holding company, it would be permitted, as part of the business of underwriting or merchant banking activity and under certain circumstances and procedures, to invest in shares or other ownership interests in, or assets of, companies engaged in non-financial activities. In order to make those investments, the Company would be required (i) to become, or to have an affiliate that is, a registered securities broker or dealer or a registered municipal securities dealer, or (ii) to control both an insurance company predominantly engaged in underwriting life, accident and health, or property and casualty insurance (other than credit insurance) or issuing annuities, and a registered investment adviser that furnishes investment advice to an insurance company. The Company does not currently have any securities, insurance, or investment advisory affiliates of the required types, nor does the Company have any current plans to make any of the equity investments described in this paragraph. The Bank's Investments. The Bank may invest its funds in a wide variety of debt instruments and may participate in the federal funds market with other depository institutions. Subject to certain exceptions, the Bank is prohibited from investing in equity securities. Among the equity investments permitted for the Bank under various conditions and subject in some instances to amount limitations, are shares of a subsidiary insurance agency (such as CS Financial Services), mortgage company (such as the Mortgage Company), real estate company, or Michigan business and industrial development company. Under another such exception, in certain circumstances and with prior notice to or approval of the FDIC, the Bank could invest up to 10% of its total assets in the equity securities of a subsidiary corporation engaged in the acquisition and development of real property for sale, or the improvement of real property by construction or rehabilitation of residential or commercial units for sale or lease. The Bank has no present plans to make such an investment. Real estate acquired by the Bank in satisfaction of or foreclosure upon loans may be held by the Bank for specified periods. The Bank is also permitted to invest in such real estate as is necessary for the convenient transaction of its business. The Bank's Board of Directors may alter the Bank's investment policy without shareholder approval at any time. ENVIRONMENTAL MATTERS The Company does not believe that existing environmental regulations will have any material effect upon the capital expenditures, earnings and competitive position of the Company. EMPLOYEES As of December 31, 2006, the Bank had 61 full-time and 22 part-time employees. No area of the Bank is represented by collective bargaining agents. 8 SELECTED STATISTICAL DATA AND RETURN ON EQUITY AND ASSETS Selected statistical data for the Company is shown for 2006, 2005 and 2004 only. CONSOLIDATED RESULTS OF OPERATIONS:
2006 2005 2004 ------------ ------------ ------------ Interest Income $ 16,489,789 $ 13,538,296 $ 10,316,411 Interest Expense 8,011,846 5,377,328 3,870,929 ------------ ------------ ------------ Net Interest Income 8,477,943 8,160,968 6,445,482 Provision for loan losses 720,701 853,728 460,067 Non interest income 1,517,425 1,263,139 977,806 Non interest expense 7,390,598 6,785,271 5,744,642 ------------ ------------ ------------ Income before income tax expense 1,884,069 1,785,108 1,218,579 Income tax expense (benefit) 568,757 572,427 414,933 ------------ ------------ ------------ Net income $ 1,315,312 $ 1,212,681 $ 803,646 CONSOLIDATED BALANCE SHEET DATA: Total assets $246,980,831 $222,166,351 $193,502,608 Cash and cash equivalents 9,070,270 4,651,459 2,375,615 Securities 18,442,272 18,902,432 16,930,341 Loans held for sale 165,070 0 0 Gross loans 207,432,376 192,644,742 171,451,202 Allowance for loan losses 2,549,016 2,612,581 2,039,198 Other assets 14,419,859 8,580,299 4,784,648 Deposits 214,282,412 190,451,101 158,820,523 Federal funds purchased and repurchase agreements 4,494,614 6,065,010 9,980,778 Federal Home Loan Bank Advances 6,000,000 6,000,000 6,000,000 Notes Payable 400,000 0 0 Subordinated Debentures 4,500,000 4,500,000 4,500,000 Other 1,585,180 650,329 801,975 Shareholders' equity 16,118,625 14,499,911 13,399,332 CONSOLIDATED FINANCIAL RATIOS: Return on average assets 0.57% 0.57% 0.42% Return on average shareholders' equity 8.59% 8.63% 6.17% Average equity to average assets 6.59% 6.60% 6.80% Dividend payout ratio N/A N/A N/A Non performing loans to total loans and leases 0.54% 0.59% 0.44% Tier 1 leverage capital ratio 8.65% 8.73% 9.35% Tier 1 leverage risk-based capital ratio 9.23% 9.48% 10.00% Total risk-based capital ratio 10.37% 10.73% 11.15%
9 SELECTED STATISTICAL DATA AND RETURN ON EQUITY AND ASSETS
Per Share Data: 2006 2005 2004 ---------- ---------- ---------- Net Income: Basic $ 0.91 $ 0.85 $ 0.56 Diluted 0.89 0.82 0.55 Book value at end of period 10.99 10.09 9.37 Dividends declared N/A N/A N/A Weighted average shares outstanding 1,447,485 1,434,185 1,430,000 Diluted average shares outstanding 1,478,168 1,471,939 1,464,362
NET INTEREST EARNINGS
Years Ended December 31: 2006 2005 Average Average Average Average Balance Interest Yield/Rate Balance Interest Yield/Rate ------------ ----------- ---------- ------------ ----------- ---------- Assets Federal funds sold and interest bearing deposits with banks $ 3,115,319 $ 144,855 4.65% $ 2,015,919 $ 62,276 3.09% Securities (1),(2) 19,371,304 843,013 4.35 18,857,818 764,305 4.05 Loans (3) 198,625,907 15,617,761 7.86 184,690,712 12,781,600 6.92 ------------ ----------- ------ ------------ ----------- ------ 221,112,530 16,605,629 7.51 205,564,449 13,608,181 6.62 Other assets 11,058,121 7,466,078 ------------ ------------ $232,170,651 $213,030,527 ============ ============ Liabilities and Shareholders' Equity Interest-bearing deposits $180,734,753 $ 7,044,480 3.90 $160,282,633 $ 4,530,508 2.83 Federal funds purchased and repurchase agreements 7,072,189 271,502 3.84 10,915,239 253,864 2.33 Subordinated debentures, notes Payable and FHLB Advances 10,805,218 695,864 6.44 10,500,000 592,956 5.65 ------------ ----------- ------ ------------ ----------- ------ 198,612,160 8,011,846 4.03 181,697,872 5,377,328 2.96 ----------- ----------- Noninterest-bearing deposits 17,505,342 16,457,530 Other liabilities 743,435 821,761 Shareholders' Equity 15,309,714 14,053,364 ------------ ------------ $232,170,651 $213,030,527 ============ ============ Net interest income (tax equivalent basis) 8,593,783 8,230,853 =========== =========== Net interest spread on earning assets (tax equivalent basis) 3.48% 3.66% ====== ====== Net interest margin on earning assets (tax equivalent basis) 3.89% 4.00% ====== ====== Average interest-earning assets to Average interest-bearing liabilities 111.33% 113.14% ====== ====== Tax equivalent adjustment 115,840 69,885 ----------- ----------- Net Interest Income $ 8,477,943 $ 8,160,968 =========== =========== Years Ended December 31: 2004 Average Average Balance Interest Yield/Rate ------------ ------------ ---------- Assets Federal funds sold and interest bearing deposits with banks $ 3,266,803 $ 34,305 1.05% Securities (1),(2) 17,932,392 623,955 3.48 Loans (3) 162,549,306 9,674,621 5.95 ------------ ------------ ------ 183,748,501 10,332,881 5.62 Other assets 7,735,187 ------------ $191,483,688 ============ Liabilities and Shareholders' Equity Interest-bearing deposits $142,608,273 $ 3,223,957 2.26 Federal funds purchased and repurchase agreements 11,585,877 150,098 1.30 Subordinated debentures, notes Payable and FHLB Advances 8,970,355 496,874 5.54 ------------ ------------ ------ 163,164,505 3,870,929 2.37 ------------ Noninterest-bearing deposits 14,628,041 Other liabilities 666,455 Shareholders' Equity 13,024,687 $191,483,688 ============ Net interest income (tax equivalent basis) 6,461,952 ============ Net interest spread on earning assets (tax equivalent basis) 3.25% ====== Net interest margin on earning assets (tax equivalent basis) 3.52% ====== Average interest-earning assets to Average interest-bearing liabilities 112.62% ====== Tax equivalent adjustment 16,470 ------------ Net Interest Income $ 6,445,482 ============
- ------------- (1) Includes Federal Home Loan Bank Stock. (2) Adjusted to a fully tax equivalent basis. (3) Includes loans held for sale and non-accrual loans. 10 RATE VOLUME ANALYSIS
Year ended December 31, Year ended December 31, 2006 over 2005 2005 over 2004 Total Volume Rate Total Volume Rate ---------- ---------- ---------- ---------- ---------- ----------- Increase (decrease) in interest income Federal funds sold and interest- bearing deposits with banks $ 82,579 $ 42,869 $ 39,710 $ 27,971 $ (17,337) $ 45,308 Securities (1),(2) 78,708 21,226 57,482 140,350 33,465 106,885 Loans (3) 2,836,161 1,011,212 1,824,949 3,106,979 1,415,536 1,691,443 ---------- ---------- ---------- ---------- ---------- ----------- Net change in interest income 2,997,448 1,075,307 1,922,141 3,275,300 1,431,664 1,843,636 Increase (decrease) in interest expense Interest-bearing deposits 2,513,971 812,716 1,701,255 1,306,551 719,581 586,970 Federal funds purchased and repurchase agreements 17,638 (109,800) 127,438 103,766 (9,157) 112,923 Subordinated debentures, notes payable and FHLB advances 102,908 17,651 85,257 96,082 86,212 9,870 ---------- ---------- ---------- ---------- ---------- ----------- Net change in interest expense 2,634,517 720,567 1,913,950 1,506,399 796,636 709,763 ---------- ---------- ---------- ---------- ---------- ----------- Net change in net interest income $ 362,931 $ 354,740 $ 8,191 $1,768,901 $ 635,028 $ 1,133,873 ========== ========== ========== ========== ========== ===========
INVESTMENT PORTFOLIO The composition of the investment portfolio is detailed in the table below.
Balance at Balance at Balance at December 31, 2006 December 31, 2005 December 31, 2004 ----------------- ----------------- ----------------- U.S. Treasuries $ 0 $ 0 $ 0 U.S. Government and federal agency 4,408,178 5,360,898 5,406,061 Municipals 5,965,351 5,625,140 1,125,097 Mortgage-backed and collateralized mortgage obligations 8,068,743 7,916,394 10,399,184 ----------------- ----------------- ----------------- $ 18,442,272 $ 18,902,432 $ 16,930,342 ================= ================= =================
The maturity schedule of the Company's investment portfolio as well as the weighted average yield for each timeframe is included in the table below.
2006 One Yr or Less 1 - 5 Years Over 5 Years Total - -------------------------- -------------- --------------- ------------- ------------ Treasury $ 0 $ 0 $ 0 $ 0 Government Agency 997,763 2,934,862 475,553 4,408,178 Municipals 363,164 1,393,240 4,208,948 5,965,352 Mortgage Backed Securities 318,365 2,320,362 5,430,016 8,068,743 -------------- --------------- ------------- ------------ Total $ 1,679,292 $ 6,648,464 $ 10,114,517 $ 18,442,273 ============== =============== ============= ============ Weighted Average Yield 2.65% 3.99% 4.37% 4.09%
Yields on tax exempt obligations have not been computed on a tax equivalent basis. - ---------------- (1) Includes Federal Home Loan Bank Stock. (2) Adjusted to a fully tax equivalent basis. (3) Includes loans held for sale and non-accrual loans. 11 INVESTMENT PORTFOLIO (CONTINUED) The table below lists the security issuers in which the aggregate holding exceeds 10% of the Company's stockholders' equity.
2006 Issuer Book Value Market Value - ---------- ------ ---------- ------------ FHLMC $3,138,872 $ 3,079,621 FNMA 6,925,902 6,763,798
LOAN PORTFOLIO The composition of the loan portfolio for each period is detailed in the following table.
December 31, 2006 December 31, 2005 December 31, 2004 December 31, 2003 December 31, 2002 Balance % Balance % Balance % Balance % Balance % ------------------- ------------------- -------------------- -------------------- ------------------- Commercial $ 90,297,059 43.5 $ 85,751,222 44.6 $ 80,385,707 46.9 $ 65,465,085 43.7 62,661,644 44.3 Real estate - Commercial 78,012,565 37.6 68,445,169 35.5 56,484,601 32.9 50,440,113 33.6 44,681,761 31.6 Real estate - Residential 10,172,321 5.0 9,366,098 4.9 7,210,940 4.2 6,213,613 4.1 5,819,289 4.1 Real estate - Construction 1,334,276 0.6 1,636,526 0.8 2,205,563 1.3 3,109,574 2.1 1,853,099 1.3 Consumer 27,616,155 13.3 27,445,727 14.2 25,164,391 14.7 24,721,700 16.5 26,437,827 18.7 ------------ ----- ------------ ----- ------------- ----- ------------- ----- ------------ ----- $207,432,376 100.0 $192,644,742 100.0 $ 171,451,202 100.0 $ 149,950,085 100.0 $141,453,620 100.0 ============ ===== ============ ===== ============= ===== ============= ===== ============ ===== Less allowance for loan losses 2,549,016 2,612,581 2,039,198 1,927,756 1,898,983 ------------ ------------ ------------- ------------- ------------ $204,883,360 $190,032,161 $ 169,412,004 $ 148,022,329 $139,554,637 ============ ============ ============= ============= ============
The non-accrual, past due and restructured loans as of the end of each period are reported below.
December 31 December 31 December 31 December 31 December 31 2006 2005 2004 2003 2002 ----------- ------------ ----------- ----------- ----------- Loans on nonaccrual status $ 401,000 $ 749,000 $ 598,000 $ 116,000 $ 521,000 Loans 90 days or more past due and accruing interest 730,000 379,000 115,000 844,000 317,000 Troubled debt restructuring 0 0 0 0 0 ----------- ------------ ----------- ----------- ----------- $ 1,131,000 $ 1,128,000 $ 753,000 $ 960,000 $ 838,000 =========== ============ =========== =========== ===========
Included below is the 2006 interest information on non-accrual, past due and restructured loans.
2006 ---------- Average of impaired loans during the year $1,090,796 Interest income recognized during impairment 15,602 Cash-basis interest income recognized 10,366
12 LOAN PORTFOLIO (CONTINUED) Below are two tables that summarize the activity in and the allocation of the Allowance for Loan Losses. Activity in the Allowance for Loan Losses:
Twelve Months Twelve Months Twelve Months Twelve Months Twelve Months Ended 12/31/06 Ended 12/31/05 Ended 12/31/04 Ended 12/31/03 Ended 12/31/02 -------------- -------------- -------------- -------------- -------------- Beginning Balance $ 2,612,581 $ 2,039,198 $ 1,927,756 $ 1,898,983 $ 1,535,543 Charge-offs Commercial (548,601) (130,602) (198,941) (177,922) 0 Real Estate - Commercial (54,000) (1,236) (23,408) (251,654) (150,740) Real Estate - Residential (5,234) 0 0 (23,363) 0 Real Estate - Construction 0 0 0 (14,247) 0 Consumer (233,858) (179,218) (222,481) (213,660) (162,781) -------------- -------------- -------------- -------------- -------------- (841,693) (311,056) (444,830) (680,846) (313,521) -------------- -------------- -------------- -------------- -------------- Recoveries Commercial 11,471 (2,799) 60,855 107,749 0 Real Estate - Commercial 0 0 2,165 31,234 6,743 Real Estate - Residential 0 0 0 14,989 0 Real Estate - Construction 0 0 0 0 0 Consumer 45,956 33,510 33,185 61,408 45,378 -------------- -------------- -------------- -------------- -------------- 57,427 30,711 96,205 215,380 52,121 -------------- -------------- -------------- -------------- -------------- Net Charge-offs (784,266) (280,345) (348,625) (465,466) (261,400) -------------- -------------- -------------- -------------- -------------- Provision charged against operating expense 720,701 853,728 460,067 494,239 624,840 -------------- -------------- -------------- -------------- -------------- Ending Balance $ 2,549,016 $ 2,612,581 $ 2,039,198 $ 1,927,756 $ 1,898,983 ============== ============== ============== ============== ==============
Allocation of the Allowance for Loan Losses:
2006 2005 2004 2003 2002 % of % of % of % of % of Loans in Loans in Loans in Loans in Loans in Each Each Each Each Each Category Category Category Category Category to Total to Total to Total to Total to Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans ---------- -------- ---------- -------- ---------- -------- ---------- -------- ---------- -------- Balance at End of Period Applicable To: Commercial $1,239,909 43.5 $1,460,911 44.6 $1,062,232 46.9 $ 996,728 43.7 $ 862,436 44.3 Real estate - Commercial 943,907 37.6 777,331 35.5 632,459 32.9 576,778 33.6 663,579 31.6 Real estate - Residential 50,862 5.0 46,830 4.9 36,055 4.2 30,708 4.1 43,645 4.1 Real estate - Construction 15,344 0.6 18,820 0.8 25,364 1.3 35,760 2.1 24,090 1.3 Consumer 298,994 13.3 308,689 14.2 283,088 14.7 287,782 16.5 305,233 18.7 Unallocated 0 0.0 0 0.0 0 0.0 0 0.0 0 0 ---------- -------- ---------- -------- ---------- -------- ---------- -------- ---------- -------- Total $2,549,016 100.0 $2,612,581 100.0 $2,039,198 100.0 $1,927,756 100.0 $1,898,983 100.00 ========== ======== ========== ======== ========== ======== ========== ======== ========== ========
As of both period ends, all loans in the portfolio were domestic; there were no foreign outstandings. For further discussion on the risk elements of the portfolio and the factors considered in determining the amount of the allowance for loan losses and for a table summarizing the scheduled maturities and interest rate sensitivity of the Company's loan portfolio see the table and information in Management's Discussion and Analysis on pages 8 through 10 of the 2006 Annual Report furnished to the Securities and Exchange Commission as Exhibit 13 to this Report, which are incorporated here by reference. 13 DEPOSITS The table below represents the average balance of deposits by category as well as the average rate. Deposits in Domestic Bank Office:
Average Average Average Average Average Average Balance 2006 Rate 2006 Balance 2005 Rate 2005 Balance 2004 Rate 2004 ------------ --------- ------------ --------- ------------ --------- Non Interest Bearing Demand $ 17,505,342 N/A $ 16,457,530 N/A $ 14,628,041 N/A Interest Bearing Demand 26,340,816 4.95% 33,271,743 2.77% 47,535,611 1.42% Savings 12,927,421 3.03 15,537,817 1.75 14,781,998 1.00 Time Deposits 141,466,516 3.78 111,473,073 2.99 80,290,664 2.99 ------------ --------- ------------ --------- ------------ --------- Total $198,240,095 3.90% $176,740,163 2.83% $157,236,314 2.26% ============ ========= ============ ========= ============ =========
The Company had no foreign banking offices at December 31, 2006. The table below represents the maturity distribution of time deposits of $100,000 or more at December 31, 2006.
Over Six Within Over Three Through Three Through Six Twelve Over Twelve Months Months Months Months Total ------------ ------------ ----------- ------------- ------------ Time Deposits > $100,000 $ 31,777,162 $ 18,300,957 $26,544,718 $ 31,958,134 $108,580,971
14 SHORT-TERM BORROWINGS On December 31, 2006, 2005, and 2004 the consolidated short-term borrowings of the Company consisted of repurchase agreements, but no federal funds purchased. Federal funds purchased are overnight borrowings from various correspondent banks. Repurchase agreements are advances by customers that are not covered by federal deposit insurance. This liability is secured by Bank owned securities, which are pledged on behalf of the repurchase account holders. Details of the Company's holdings at the specified year-ends are as follows:
Repurchase Federal Funds Agreements Purchased ------------- -------------- Outstanding at December 31, 2006 $ 4,494,614 $ 0 Average interest rate at year end 3.34% 0.00% Average balance during year 4,993,710 2,078,479 Average interest rate during year 3.17% 5.46% Maximum month end balance during year 5,758,378 6,700,000 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 Outstanding at December 31, 2004 $ 9,980,778 $ 0 Average interest rate at year end 1.24% 0.00% Average balance during year 9,314,156 2,271,721 Average interest rate during year 1.16% 1.86% Maximum month end balance during year 11,480,726 5,550,000
INTEREST RATE SENSITIVITY The interest sensitivity of the Company's consolidated balance sheet at December 31, 2006 and discussion of interest rate sensitivity are incorporated here by reference to Management's Discussion and Analysis at pages 14 and 15 of the 2006 Annual Report furnished to the Securities and Exchange Commission as Exhibit 13 to this Report. ITEM 2. DESCRIPTION OF PROPERTY The Company's and Bank's main office is located at 1030 W. Norton Avenue, Roosevelt Park, Michigan, a suburb of Muskegon. The building is approximately 11,500 square feet with a three lane drive-up, including a night depository and ATM. The Bank's second location is at 15190 Newington Drive, Grand Haven, Michigan. The Bank secured a lease on September 1, 1999, which had a term of five years. On April 8, 2004, the Bank exercised its renewal option and extended the lease for an additional three years under the same terms as the original lease. The leased space has 2,075 square feet of office space and one drive-up lane. A stand-alone ATM is also available at the Grand Haven location. In December of 2005, the Bank acquired 1.25 acres of property for $1.13 million and late in the third quarter of 2006 began construction of a new banking facility. The Bank expects to relocate its existing Grand Haven office to this location at 1120 S. Beacon Boulevard, Grand Haven, Michigan, once its lease expires in 2007. 15 For more information on the Company's future lease commitments see Note 11 on page 37 of the 2006 Annual Report furnished to the Securities and Exchange Commission as Exhibit 13 to this Report, which information regarding lease commitments is incorporated here by reference. The third banking location is at 180 Causeway Road in the City of North Muskegon and is slightly more than 4,000 square feet. The facility has a three lane drive-up, including a night depository and an ATM. In November of 2006, the Bank completed construction of its fourth banking location at Harvey and Mt. Garfield Road, in Norton Shores. The two-story facility is a little less than 20,000 square feet with a three-lane drive-up, including a night depository and an ATM. In October 2006, the Bank finalized the purchase of vacant land located on Apple Avenue at Quarterline in the City of Muskegon. The purchase price of the property was $721,000. The intention of the Bank is to build a fifth banking location. ITEM 3. LEGAL PROCEEDINGS From time to time, the Company and the Bank may be involved in various legal proceedings that are incidental to their business. In the opinion of management, neither the Company nor the Bank is a party to any current legal proceedings that are material to the financial condition of the Company or the Bank, either individually or in aggregate. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of 2006 to a vote of the Company's shareholders. 16 PART II ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES The information listed under the caption "Stock Information" on page 46 of the 2006 Annual Report furnished to the Securities and Exchange Commission as Exhibit 13 to this Report are incorporated here by reference. EQUITY PLAN COMPENSATION INFORMATION The following table summarizes information, as of December 31, 2006, relating to the Company's compensation plans under which equity securities are authorized for issuance.
Number of securities Number of securities Weighted average remaining available for to be issued upon exercise price of future issuance under equity exercise of outstanding outstanding compensation plans options, options, warrants (excluding securities Plan Category warrants and rights and rights reflected in column (a)) - ------------- ----------------------- ----------------- ---------------------------- (a) (b) (c) Equity compensation plans 115,775 $10.74 55,000 approved by security holders (1) Equity compensation plans not 0 0 0 approved by security holders Total 115,775 $10.74 55,000
- ------------ (1) The plans referred to are the Company's Employee Stock Option Plans of 1998 and 2005 and the Director Stock Option Plans of 2003 and 2005. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION The information shown under the caption "Management's Discussion and Analysis" beginning on page 5 of the 2006 Annual Report furnished to the Securities and Exchange Commission as Exhibit 13 to this Report is incorporated here by reference. 17 ITEM 7. FINANCIAL STATEMENTS The information presented under the captions "Consolidated Balance Sheets," "Consolidated Statements of Income," "Consolidated Statements of Changes in Shareholders' Equity," "Consolidated Statements of Cash Flows," and "Notes to Consolidated Financial Statements," as well as the Report of Independent Registered Public Accounting Firm, Crowe Chizek and Company LLC, dated March 14, 2007, in the 2006 Annual Report furnished to the Securities and Exchange Commission as Exhibit 13 to this Report is incorporated here by reference. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 8A. CONTROLS AND PROCEDURES As of December 31, 2006, an evaluation was performed under the supervision of and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company's disclosure controls and procedures were effective as of December 31, 2006. There have been no significant changes in the internal controls over financial reporting during the quarter ended December 31, 2006, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. ITEM 8B. OTHER INFORMATION None. 18 PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT The information presented under the captions "Election of Directors-Information about Directors, Nominees and Executive Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive Proxy Statement for its May 10, 2007 annual meeting of shareholders (the "Proxy Statement"), a copy of which will be filed with the Securities and Exchange Commission before the meeting date, is incorporated here by reference. The Company has a separately designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934. The members of the Audit Committee consist of Joy R. Nelson, Bruce C. Rice and Roger W. Spoelman. The Board of Directors has determined that it does not have a member of the Audit Committee that is qualified as an audit committee financial expert, as that term is defined in the rules of the Securities and Exchange Commission. The Board of Directors of the Company believes that the financial sophistication of the Audit Committee is sufficient to meet the needs of the Company and its shareholders. The Company has adopted a Code of Ethics that applies to all of the directors, officers and employees, including the principal executive officer, principal financial officer, principal accounting officer or controller, and persons performing similar functions. The Code of Ethics is filed as Exhibit 14 to this Report. ITEM 10. EXECUTIVE COMPENSATION The information presented under the caption "Executive Compensation" in the Proxy Statement is incorporated here by reference. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information presented under the caption "Stock Ownership of Certain Beneficial Owners and Management" in the Proxy Statement is incorporated here by reference. The information in Item 5 of this Report under the caption "Equity Plan Compensation Information" is incorporated here by reference. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE The information presented under the captions "Corporate Governance-Director Independence" and "Transactions with Related Persons" in the Proxy Statement is incorporated here by reference. 19 ITEM 13. EXHIBITS
EXHIBIT NO. EXHIBIT DESCRIPTION 3.1 Articles of Incorporation are incorporated by reference to exhibit 3.1 of the Company's June 30, 2004 Form 10-QSB (SEC file no. 333-63769). 3.2 Bylaws of the Company are incorporated by reference to exhibit 3(ii) of the Company's 8-K filed July 5, 2006 (SEC file no. 000-5166) 10.1 1998 Employee Stock Option Plan is incorporated by reference to exhibit 10.1 of the Company's Registration Statement on Form SB-2 (SEC File no. 333-63769), which became effective on December 17, 1998. * 10.2 First Amendment to 1998 Employee Stock Option Plan is incorporated by reference to exhibit 10.3 of the Company's Registration Statement on Form SB-2 (SEC File no. 333-63769), which became effective on December 17, 1998. * 10.3 Director Stock Option Plan is incorporated by reference to exhibit 10.53 of the Company's December 31, 2003 Form 10-KSB (SEC file no. 333-63769). * 10.4 Agreement between Fiserv Solutions, Inc. and Community Shores Bank is incorporated by reference to exhibit 10.4 of the Company's Registration Statement on Form SB-2 (SEC File no. 333-63769) which became effective on December 17, 1998. 10.5 Junior Subordinated Indenture between Community Shores Bank Corporation and Deutsche Bank Trust Company Americas, as Trustee dated as of December 17, 2004 is incorporated by reference to exhibit 10.20 of the Company's December 31, 2004 Form 10-KSB (SEC file no. 000-51166). 10.6 Amended and Restated Trust Agreement among Community Shores Bank Corporation, as Depositor, Deutsche Bank Trust Company Americas, as Property Trustee, Deutsche Bank Trust Company Delaware, as Delaware Trustee, and The Administrative Trustees Named Herein as Administrative Trustees dated as of December 17, 2004 is incorporated by reference to exhibit 10.21 of the Company's December 31, 2004 Form 10-KSB (SEC file no. 000-51166). 10.7 Guarantee Agreement between Community Shores Bank Corporation, as Guarantor, and Deutsche Bank Trust Company Americas, as Guarantee Trustee dated as of December 17, 2004 is incorporated by reference to exhibit 10.22 of the Company's December 31, 2004 Form 10-KSB (SEC file no. 000-51166). 10.8 Placement Agreement among Community Shores Bank Corporation, Community Shores Capital Trust I and Suntrust Capital Markets, Inc. dated as of December 17, 2004 is incorporated by reference to exhibit 10.23 of the Company's December 31, 2004 Form 10-KSB (SEC file no. 000-51166).
- -------------- * Management contract or compensatory plan or arrangement. 20 10.9 Purchase Agreement between Community Shores Bank and POT #103, Inc. is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed May 9, 2005 (SEC file no. 000-51166). 10.10 Development Coordination Agreement with Investment Property Associates, Inc is incorporated by reference to exhibit 10.1 of the Company's May 9, 2005 Form 8-K filed May 10, 2005 (SEC file no. 000-51166). 10.11 2005 Employee Stock Option Plan is incorporated by reference to Appendix A of the Company's proxy statement for its May 12, 2005 annual meeting of shareholders (SEC file no. 000-51166).* 10.12 2005 Director Stock Option Plan is incorporated by reference to Appendix B of the Company's proxy statement for its May 12, 2005 annual meeting of shareholders (SEC file no. 000-51166).* 10.13 Form of stock option agreement for options granted under the 2005 Employee Stock Option Plan is incorporated by reference to exhibit 10.3 of the Company's Form 8-K filed May 17, 2005 (SEC file no. 000-51166).* 10.14 Form of stock option agreement for options granted to directors under the 2005 Director Stock Option Plan is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed December 13, 2005.* 10.15 Purchase Agreement between Community Shores Bank and Baumgardner-Hogan Real Estate, LLC is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed November 2, 2005 (SEC file number 000-51166). 10.16 Purchase Agreement between Community Shores Bank and Williamsburg Court Apartments, LLC is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed November 10, 2005 (SEC file no. 000-51166). 10.17 Replacement Revolving Loan Agreement between Community Shores Bank Corporation and LaSalle Bank National Association dated August 1, 2005 is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed December 16, 2005 (SEC file no. 000-51166). 10.18 First Amendment to Revolving Loan Agreement and Cancellation of Pledge Agreement between Community Shores Bank Corporation and LaSalle Bank National Association dated August 1, 2005 is incorporated by reference to exhibit 10.2 of the Company's Form 8-K filed December 16, 2005 (SEC file no. 000-51166). 10.19 Development Coordination Agreement with Investment Property Associates, Inc. is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed April 18, 2006 (SEC file no. 000-51166).
- ------------- * Management contract or compensatory plan or arrangement. 21 10.20 Extension to the agreement between Fiserv Solutions, Inc. and Community Shores Bank is incorporated by reference to exhibit 10.2 of the Company's Form 8-K filed July 7, 2006 (SEC File no. 000-51166). 10.21 Addendum #2 to the Buy and Sell Agreement with Baumgardner-Hogan Real Estate, LLC is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed May 18, 2006 (SEC File no. 000-51166). 10.22 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 Form 8-K filed July 11, 2006 (SEC File no. 000-51166). 10.23 Extension Revolving Loan Agreement between Community Shores Bank Corporation and LaSalle Bank National Association dated August 1, 2006 is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed September 11, 2006 (SEC file no. 000-51166). 10.24 Second Amendment to Revolving Loan Agreement between Community Shores Bank Corporation and LaSalle Bank National Association dated August 1, 2006 is incorporated by reference to exhibit 10.2 of the Company's Form 8-K filed September 11, 2006 (SEC file no. 000-51166). 10.25 Addendum #4 to Buy and Sell Agreement with Baumgardner-Hogan Real Estate, LLC extending the contingency period is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed September 27, 2006 (SEC file no. 000-51166). 10.26 Community Shores Bank Corporation Executive Incentive Plan is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed February 2, 2007 (SEC file no. 000-51166)*. 10.27 Summary of 2007 Director Compensation Arrangement. * 13 2006 Annual Report to Shareholders of the Company. Except for the portions of the 2006 Annual Report that are expressly incorporated by reference in this Annual Report on Form 10-KSB, the 2006 Annual Report of the Company shall not be deemed filed as a part of this Annual Report on Form 10-KSB. 14 Code of Ethics is incorporated by reference to exhibit 14 of the Company's December 31, 2003 Form 10-KSB (SEC file no. 333-63769). 21 Subsidiaries of the Issuer. 23 Consent of Independent Registered Public Accounting Firm. 31.1 Rule 13a-14(a) Certification of the principal executive officer
- ------ * Management contract or compensatory plan or arrangement. 22 31.2 Rule 13a-14(a) Certification of the principal financial officer. 32.1 Section 1350 Chief Executive Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Section 1350 Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. The information presented under the caption "Ratification of Appointment of Independent Registered Public Accountants-Principal Accountant Fees and Services" in the Proxy Statement is incorporated here by reference. 23 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 28, 2007. COMMUNITY SHORES BANK CORPORATION /s/ Heather D. Brolick ________________________________________________ Heather D. Brolick President, Chief Executive Officer and Secretary In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant, and in the capacities indicated on March 28, 2007. /s/ Gary F. Bogner ____________________________________ _______________________________________ Gary F. Bogner, Chairman Joy R. Nelson, Director /s/ Dennis L. Cherette /s/ Bruce C. Rice ____________________________________ _______________________________________ Dennis L. Cherette, Vice Chairman Bruce C. Rice, Director /s/ Robert L. Chandonnet ____________________________________ _______________________________________ Robert L. Chandonnet, Director Roger W. Spoelman, Director /s/ Steven P. Moreland ____________________________________ _______________________________________ Jonathon L. Smith, Director Steven P. Moreland, Director /s/ Bruce J. Essex ____________________________________ Bruce J. Essex, Director /s/ Heather D. Brolick /s/ Tracey A. Welsh ____________________________________ _______________________________________ Heather D. Brolick, President, Chief Tracey A. Welsh, Senior Vice President, Executive Officer and Director Chief Financial Officer and Treasurer (principal executive officer) (principal financial and accounting officer) 24 EXHIBIT INDEX
EXHIBIT NO. EXHIBIT DESCRIPTION 3.1 Articles of Incorporation are incorporated by reference to exhibit 3.1 of the Company's June 30, 2004 Form 10-QSB (SEC file no. 333-63769). 3.2 Bylaws of the Company are incorporated by reference to exhibit 3(ii) of the Company's 8-K filed July 5, 2006 (SEC file no. 000-5166) 10.1 1998 Employee Stock Option Plan is incorporated by reference to exhibit 10.1 of the Company's Registration Statement on Form SB-2 (SEC File no. 333-63769), which became effective on December 17, 1998. * 10.2 First Amendment to 1998 Employee Stock Option Plan is incorporated by reference to exhibit 10.3 of the Company's Registration Statement on Form SB-2 (SEC File no. 333-63769), which became effective on December 17, 1998. * 10.3 Director Stock Option Plan is incorporated by reference to exhibit 10.53 of the Company's December 31, 2003 Form 10-KSB (SEC file no. 333-63769). * 10.4 Agreement between Fiserv Solutions, Inc. and Community Shores Bank is incorporated by reference to exhibit 10.4 of the Company's Registration Statement on Form SB-2 (SEC File no. 333-63769) which became effective on December 17, 1998. 10.5 Junior Subordinated Indenture between Community Shores Bank Corporation and Deutsche Bank Trust Company Americas, as Trustee dated as of December 17, 2004 is incorporated by reference to exhibit 10.20 of the Company's December 31, 2004 Form 10-KSB (SEC file no. 000-51166). 10.6 Amended and Restated Trust Agreement among Community Shores Bank Corporation, as Depositor, Deutsche Bank Trust Company Americas, as Property Trustee, Deutsche Bank Trust Company Delaware, as Delaware Trustee, and The Administrative Trustees Named Herein as Administrative Trustees dated as of December 17, 2004 is incorporated by reference to exhibit 10.21 of the Company's December 31, 2004 Form 10-KSB (SEC file no. 000-51166). 10.7 Guarantee Agreement between Community Shores Bank Corporation, as Guarantor, and Deutsche Bank Trust Company Americas, as Guarantee Trustee dated as of December 17, 2004 is incorporated by reference to exhibit 10.22 of the Company's December 31, 2004 Form 10-KSB (SEC file no. 000-51166). 10.8 Placement Agreement among Community Shores Bank Corporation, Community Shores Capital Trust I and Suntrust Capital Markets, Inc. dated as of December 17, 2004 is incorporated by reference to exhibit 10.23 of the Company's December 31, 2004 Form 10-KSB (SEC file no. 000-51166).
- ------------- * Management contract or compensatory plan or arrangement. 25 10.9 Purchase Agreement between Community Shores Bank and POT #103, Inc. is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed May 9, 2005 (SEC file no. 000-51166). 10.10 Development Coordination Agreement with Investment Property Associates, Inc is incorporated by reference to exhibit 10.1 of the Company's May 9, 2005 Form 8-K filed May 10, 2005 (SEC file no. 000-51166). 10.11 2005 Employee Stock Option Plan is incorporated by reference to Appendix A of the Company's proxy statement for its May 12, 2005 annual meeting of shareholders (SEC file no. 000-51166).* 10.12 2005 Director Stock Option Plan is incorporated by reference to Appendix B of the Company's proxy statement for its May 12, 2005 annual meeting of shareholders (SEC file no. 000-51166).* 10.13 Form of stock option agreement for options granted under the 2005 Employee Stock Option Plan is incorporated by reference to exhibit 10.3 of the Company's Form 8-K filed May 17, 2005 (SEC file no. 000-51166).* 10.14 Form of stock option agreement for options granted to directors under the 2005 Director Stock Option Plan is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed December 13, 2005.* 10.15 Purchase Agreement between Community Shores Bank and Baumgardner-Hogan Real Estate, LLC is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed November 2, 2005 (SEC file number 000-51166). 10.16 Purchase Agreement between Community Shores Bank and Williamsburg Court Apartments, LLC is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed November 10, 2005 (SEC fileno. 000-51166). 10.17 Replacement Revolving Loan Agreement between Community Shores Bank Corporation and LaSalle Bank National Association dated August 1, 2005 is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed December 16, 2005 (SEC file no. 000-51166). 10.18 First Amendment to Revolving Loan Agreement and Cancellation of Pledge Agreement between Community Shores Bank Corporation and LaSalle Bank National Association dated August 1, 2005 is incorporated by reference to exhibit 10.2 of the Company's Form 8-K filed December 16, 2005 (SEC file no. 000-51166). 10.19 Development Coordination Agreement with Investment Property Associates, Inc. is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed April 18, 2006 (SEC file no. 000-51166).
- -------------- * Management contract or compensatory plan or arrangement. 26 10.20 Extension to the agreement between Fiserv Solutions, Inc. and Community Shores Bank is incorporated by reference to exhibit 10.2 of the Company's Form 8-K filed July 7, 2006 (SEC File no. 000-51166). 10.21 Addendum #2 to the Buy and Sell Agreement with Baumgardner-Hogan Real Estate, LLC is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed May 18, 2006 (SEC File no. 000-51166). 10.22 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 Form 8-K filed July 11, 2006 (SEC File no. 000-51166). 10.23 Extension Revolving Loan Agreement between Community Shores Bank Corporation and LaSalle Bank National Association dated August 1, 2006 is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed September 11, 2006 (SEC file no. 000-51166). 10.24 Second Amendment to Revolving Loan Agreement between Community Shores Bank Corporation and LaSalle Bank National Association dated August 1, 2006 is incorporated by reference to exhibit 10.2 of the Company's Form 8-K filed September 11, 2006 (SEC file no. 000-51166). 10.25 Addendum #4 to Buy and Sell Agreement with Baumgardner-Hogan Real Estate, LLC extending the contingency period is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed September 27, 2006 (SEC file no. 000-51166). 10.26 Community Shores Bank Corporation Executive Incentive Plan is incorporated by reference to exhibit 10.1 of the Company's Form 8-K filed February 2, 2007 (SEC file no. 000-51166)*. 10.27 Summary of 2007 Director Compensation Arrangement. * 13 2006 Annual Report to Shareholders of the Company. Except for the portions of the 2006 Annual Report that are expressly incorporated by reference in this Annual Report on Form 10-KSB, the 2006 Annual Report of the Company shall not be deemed filed as a part of this Annual Report on Form 10-KSB. 14 Code of Ethics is incorporated by reference to exhibit 14 of the Company's December 31, 2003 Form 10-KSB (SEC file no. 333-63769). 21 Subsidiaries of the Issuer. 23 Consent of Independent Registered Public Accounting Firm. 31.1 Rule 13a-14(a) Certification of the principal executive officer 31.2 Rule 13a-14(a) Certification of the principal financial officer.
- ------------- * Management contract or compensatory plan or arrangement. 27 32.1 Section 1350 Chief Executive Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Section 1350 Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
28 EX-10.27 2 k13450exv10w27.txt SUMMARY OF 2007 DIRECTOR COMPENSATION AGREEMENT EXHIBIT 10.27 SUMMARY OF 2007 DIRECTOR COMPENSATION ARRANGEMENT The non-employee directors of the Company and the Bank will each be paid, in aggregate, an annual retainer of $2,000. Non-employee directors of the Company and the Bank will also receive a fee of $250 for each meeting of the Board of Directors or a committee of the Board of Directors that they attend. The Chairman or Vice Chairman of the Board of the Bank and the Company is to receive an additional $150 for each meeting of the Board of Directors that he chairs. All committee chairmen will receive an additional $50 for each committee meeting that they chair. When meetings are held on the same day of the Boards of Directors of the Company and the Bank, or committees of the Company and the Bank performing similar functions, directors usually receive only one meeting and chairperson fee for the two Board or committee meetings. EX-13 3 k13450exv13.txt 2006 ANNUAL REPORT TO SHAREHOLDERS EXHIBIT 13 COMMUNITY SHORES BANK CORPORATION 2006 ANNUAL REPORT DECEMBER 31, 2006 SELECTED FINANCIAL INFORMATION At or For the Year Ended December 31,
(dollars in thousands, except per share data) 2006 2005 2004 -------- -------- -------- RESULTS OF OPERATIONS: Net interest income $ 8,478 $ 8,161 $ 6,446 Provision for loan losses 721 854 460 Noninterest income 1,517 1,263 978 Noninterest expense 7,390 6,785 5,745 -------- -------- -------- Income before income tax expense 1,884 1,785 1,219 Income tax expense 569 572 415 -------- -------- -------- Net income 1,315 1,213 804 -------- -------- -------- FINANCIAL CONDITION: Total assets 246,981 222,166 193,503 Total loans 207,432 192,645 171,451 Allowance for loan losses 2,549 2,613 2,039 Securities 18,442 18,902 16,930 Deposits 214,282 190,451 158,821 Federal funds purchased and repurchase agreements 4,495 6,065 9,981 Notes payable and FHLB advances 10,900 10,500 10,500 Shareholders' equity 16,119 14,500 13,399 -------- -------- -------- PERFORMANCE RATIOS: Return on average assets 0.57% 0.57% 0.42% Return on average shareholders' equity 8.59 8.63 6.17 Net interest margin (tax equivalent) 3.89 4.00 3.52 Efficiency ratio 73.94 72.00 77.32 PER SHARE DATA: Earnings per share - basic $ 0.91 $ 0.85 $ 0.56 Earnings per share - diluted 0.89 0.82 0.55 Book value per share 10.99 10.09 9.37 CAPITAL RATIOS: Tier 1 risk-based capital 9.23% 9.48% 10.00% Total risk-based capital 10.37 10.73 11.15 ======== ======== ========
COMMUNITY SHORES BANK CORPORATION Muskegon, Michigan 2006 ANNUAL REPORT CONTENTS MESSAGE TO THE SHAREHOLDERS................................................ 2 MANAGEMENT'S DISCUSSION AND ANALYSIS....................................... 5 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.................... 21 CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS............................................. 22 CONSOLIDATED STATEMENTS OF INCOME....................................... 23 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY.............. 24 CONSOLIDATED STATEMENTS OF CASH FLOWS................................... 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.............................. 26 SHAREHOLDER INFORMATION.................................................... 46 OFFICERS AND DIRECTORS..................................................... 48
TO OUR SHAREHOLDERS This past year was one of challenges, successes, opportunities and change. CHALLENGES Our challenges included battling a weakening Michigan economy, as well as an inverted yield curve. Despite these detractors, we reported a 6.2% increase in net revenue. This resulted in earnings per diluted share of $0.89, a respectable 8.5% increase. Importantly, we made significant strides in our endeavor to increase non-interest income. We outperformed our peers achieving a 20.1% increase over last year. Our net interest income increased a modest 3.9% as we experienced a slight degree of margin compression. While our great state has seen better times, it is important to note that West Michigan continues to be a bright spot in which to do business. According to the Upjohn Institute, Muskegon County outperformed the nation in two critical growth sectors: service providing and professional services. Additionally, the County has out paced the nation in manufacturing employment since 2003. While the auto industry may be struggling, its income and wealth generation capacity is still significant and it is fueling capital expenditure and production in our market area. In Ottawa County, the furniture industry has recovered and economic conditions are improving. Community Shores Bank's lenders, management and directors have an excellent knowledge of the business climate in the markets we serve. We are well positioned to maximize business in areas of positive growth. SUCCESSES Lending As a true community bank, we bring traditional banking value to small and mid-size businesses. We believe in high touch, high service partnerships where our banking professionals bring knowledge and expertise to an entire business relationship. Enhancing our ability to provide greater financing accessibility to new and existing companies, through expanded lending capabilities with the U.S. Small Business Administration (SBA), was a priority throughout our organization in 2006. Our results in this initiative were outstanding. Having attained preferred lender status with the SBA, the bank originated 30% of the total SBA loans and 29% of the total dollars in Muskegon County. Within one year, we have become Muskegon County's number one SBA lender. We are also proud to employ the U.S. Small Business Administration's Michigan Financial Services Champion for 2006, Mr. Eric Seifert. These achievements have provided us with opportunities to expand our business customer base and deepen our existing relationships. Additionally, through the secondary market sale of the guaranteed portion of these loans, we increased fee income and ultimately improved earnings. We anticipate further success in this endeavor going forward. Branching A large portion of our plans for expansion, described in last year's shareholder letter, were realized during this past year. The grand opening of our fourth location on Harvey Street, across from the Lakes Mall in Southwestern Muskegon County, was attended by over 200 of our customers, business partners and shareholders. Within three months of operation, transaction counts have shown this strategically located branch to have succeeded in adding convenience for our growing customer base. We are also creating new introductions to our Bank and generating fee income through this office's ATM, where 28% of the monthly transactions are "foreign" or non customer. The relocation of our North Muskegon Branch, to the Causeway, was also a tremendous success. At the previous location, our loyal customers tolerated one drive through lane--a lane also shared by an ATM and 2 night drop--for over five long years. The much awaited full service office opened with a bang and we were rewarded with $1.7 million dollars in new customer business within the first two months of moving. Including new accounts from existing customers, the office generated $3.7 million dollars in deposits during the months of January and February, 2007. The new site has improved accessibility, visibility and, more importantly, evidences a renewed commitment to the communities we serve. Following these branching accomplishments is the relocation of our Grand Haven office to Beacon Boulevard at Taylor. Construction is underway and completion is scheduled for August of this year. As this branch facility takes shape, it clearly communicates our intention to visually brand our locations through architectural design. Our signature blue roof has quickly become a trademark identifier! While already showing signs of success, your Board of Directors is sensitive to the associated expense of our investments in infrastructure. We strongly believe that the execution of strategic branching initiatives will strengthen the value of the franchise and improve performance through the generation of lower costing deposits and asset growth. This translates into increased shareholder value. Firmly establishing our footprint is both proactive and defensive, and will insure that we maintain a strong competitive advantage. OPPORTUNITIES People All banks, and especially community banks, laud the talents of their people. After all, community banking is not a commodity, but is about relationships. We all strive to employ the most knowledgeable, personable and professional talent available. Your Board and Management believe that we not only strive, but are successful in this effort by virtue of our steadfast commitment to empowerment. We value the experience and contributions that each staff member is able to make. We provide our people with education, tools and a structure that uses their individual business aptitude in decision making. This is in stark contrast to the development and hand off method of the centralized decision process utilized by our competitors. Our people truly represent opportunity for Community Shores Bank. During 2006 we increased staff by 20%, primarily in sales and service positions. As each individual joined the company, they embraced our culture. In doing so, they increase our circle of influence, create energy and generate excitement internally and externally for our organization. These factors will foster growth and provide business prospects despite a soft economic environment. Mortgage Banking As a strong community is diverse, so is a community based bank with a diverse lending portfolio. While commercial lending has been forefront and center to our business model since we opened our doors in 1999, the time has come to purposefully expand into other business lines. We know the housing market is not robust, yet we believe this is the best time to lay a foundation for a concerted entry into the mortgage origination market. We have provided customers with mortgage loans, but until now, have not chosen to maximize upon secondary market origination. It is our intention, over the next two years, to broaden our mortgage portfolio and increase non-interest income through the development of a strong secondary market sales effort. Retail sales opportunities, presented by a strong mortgage program, are significant. They include equity loans and an array of full service banking products. CHANGE Management There are always positive and negative aspects to change. A change in the top leadership position of any organization can not be trivialized, especially in a company that values its people and relationships as much as 3 Community Shores Bank. Your Board of Directors believed it imperative that while the person serving as President and Chief Executive Officer changed, the mission, vision, culture and core values of the organization remained constant. By adhering to our founding tenets, and improving our governance, we believe that we strengthened our franchise, positioning us for the creation of greater shareholder value. Management style is an important factor in defining organizational culture. We leverage individual talent through team work. The eight people comprising the Executive Officers of the Company, Senior Vice Presidents, and Management Team of the Bank have over 250 years of combined banking experience. With this amount of tenure, it is obvious that we consider banking a true profession and approach it passionately. It is not simply a "career," it is about making a difference in the communities in which we live. Board of Directors In the post Enron world of SOX 404, a strong, active and engaged board of directors is critical to any publicly held company. The Community Shores Bank Corporation Board of Directors is comprised of individuals who have these attributes and are committed to representing you, our shareholders effectively. In May of this past year, Mr. Gary Bogner, a founding director, resident and business owner from North Muskegon, was elected Chairman of the Company and Bank Boards. Mr. Dennis Cherette, a founding director, resident and business owner from Grand Haven, was elected Vice Chairman of the same boards. Expanding our leadership constituted another positive change as we welcomed Mr. Steven P. Moreland and Mr. Jonathan L. Smith to the board of directors of Community Shores Bank Corporation and Community Shores Bank. Steve is the President and Owner of Automatic Spring Products in Grand Haven. He brings manufacturing experience, process engineering, competitive insight and business acumen to the Board. Jon is an experienced banker, consultant and former officer of Security Capital Group, a NYSE traded company. He brings a wealth of banking experience to the Board, having begun his career with Citigroup in New York City where he was responsible for a variety of national and international businesses including commercial real estate; asset based lending and leveraged buy-outs. In 2003, he returned to his home town of Grand Rapids to oversee all of the Corporate Banking business of Fifth Third Bank, serving as its Executive Vice President. Jon is currently employed in Grand Haven at Investment Property Associates. The collective talent, knowledge, energy and resources of your Board of Directors and management team are focused on growing our business, improving profitability and enhancing shareholder value. We appreciate your investment in the Company and your patronage as customers. In Closing Webster defines community as a "unified body of individuals" and as "having joint ownership or participation." We embody this definition not only in our name, but in our actions. In every respect, we are a working and contributing participant in the vibrant communities we serve. We are like no other bank you know. Heather D. Brolick President and Chief Executive Officer Community Shores Bank Corporation 4 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS INTRODUCTION Community Shores Bank Corporation ("the Company") is a Michigan corporation and is the holding company for Community Shores Bank ("the Bank") and Community Shores Mortgage Company ("the Mortgage Company"), a wholly-owned subsidiary of the Bank. On September 27, 2002, the Company received regulatory approval to become a financial holding company and created Community Shores Financial Services ("CS Financial Services"). In December 2004, a business trust subsidiary was formed called Community Shores Capital Trust I ("the Trust"). The Bank commenced operations on January 18, 1999. The Bank is a Michigan chartered bank with depository accounts insured by the Federal Deposit Insurance Corporation. The Bank provides a full range of commercial and consumer banking services in Muskegon County and Northern Ottawa County, Michigan. The Bank currently has four locations from which to serve the communities of Muskegon and Grand Haven. The Mortgage Company, a wholly-owned subsidiary of the Bank, was formed on March 1, 2002 by transferring a majority of the Bank's commercial and residential real estate loans in exchange for 100% of the equity capital of the Mortgage Company. On the day that the Mortgage Company commenced operations it began originating residential mortgage loans with the intent to sell them to a third party for a profit. The Bank services all of the portfolio loans held by the Mortgage Company pursuant to a servicing agreement. Management chose to form the Mortgage Company to provide better customer service and to increase the profitability of the mortgage function as well as the consolidated Company. The Company filed an election to become a financial holding company pursuant to Title I of the Gramm-Leach-Bliley Act and on September 27, 2002 received regulatory approval. At that time the Company formed CS Financial Services. In 2005, the Michigan Bankers Insurance Center, LLC legally dissolved its partnership of which CS Financial Services held a 1.86% ownership interest. Currently the only source of revenue that CS Financial Services receives is referral fee income from a local insurance agency, Lakeshore Employee Benefits, formerly Lead Financial. Lakeshore Employee Benefits offers amongst other things employer-sponsored benefit plans. CS Financial Services has the opportunity to earn a referral fee for each sale of employer-sponsored benefits that is transacted by Lakeshore Employee Benefits as a result of a referral made by CS Financial Services. In December of 2004, the Company formed Community Shores Capital Trust I, a Delaware business trust. The Trust is administered by a Delaware trust company, and three individual administrative trustees who are employees and officers of the Company. The Trust was established for the purpose of issuing and selling its preferred securities and common securities and used the proceeds from the sales of those securities to acquire subordinated debentures issued by the Company. A majority of the net proceeds received by the Company was used to pay down the outstanding balance on the Company's line of credit. The remaining proceeds were used to contribute capital to the Bank as well as support the general operating expenses of the Company, including the debt service on the Company's subordinated debentures. The Company's growth in 2006 was slightly less than the level achieved in 2005. In general, 2006's growth was supported by the Bank's earnings. Projections for 2007 indicate that the Company has access to sufficient funds, via a $5 million line of credit with LaSalle Bank National Association, to meet its cash requirements and support the Bank's expected growth. The Capital Committee of the Bank recognizes that this is only a short term solution and meets periodically to assess the short and long term capital needs of the Company. As of December 31, 2006, the Bank had 61 full-time employees and 22 part time employees, an increase of 10 full time and 2 part time positions since December 31, 2005. To accommodate growth, management anticipates increasing staff by 10 full time equivalent employees during the year 2007. 5 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS CRITICAL ACCOUNTING POLICIES AND ESTIMATES The purpose of this section of the Annual Report is to provide a narrative discussion about the Company's financial condition and results of operations during 2006. The "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as disclosures found elsewhere in the Annual Report are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. One material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses. Actual results could differ from the estimate. Allowance for loan losses. The allowance for loan losses is maintained at a level believed adequate by management to absorb probable losses inherent in the consolidated loan portfolio. Management's evaluation of the adequacy of the allowance is an estimate based on reviews of individual loans, assessments of the impact of current and anticipated economic conditions on the portfolio and historical loss experience. See the Financial Condition section of Management's Discussion and Analysis and Notes 1 and 3 to the Company's consolidated financial statements for additional information. Management believes the accounting estimate related to the allowance for loan losses is a "critical accounting estimate" because (1) the estimate is highly susceptible to change from period to period because of assumptions concerning the changes in the types and volumes of the portfolios and anticipated economic conditions and (2) the impact of recognizing an impairment or loan loss could have a material effect on the Company's assets reported on the balance sheet as well as its net income. Management has discussed the development of this critical accounting estimate with the Board of Directors, and the Audit Committee. FORWARD-LOOKING STATEMENTS This discussion and analysis of financial condition and results of operations, and other sections of the Annual Report 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 CS 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; the ability of the Company to borrow money or raise additional capital when desired to support future growth; 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. 6 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS 2006 OVERVIEW The Company's assets grew by 11% to $247.0 million at December 31, 2006. The Company achieved its sixth fully profitable year of operations. For 2006, diluted earnings per share of the Company were $0.89. Year over year earnings per share increased 8.5%. Improvements in the Company's net interest income as well as profits from loan sales positively impacted the bottom line. The Bank's average earning assets grew 7.6% during 2006, which helped improve the Company's net interest income. The increases in gains on loan sales were derived mainly from the sale of Small Business Administration ("SBA")-affiliated loans. Late in 2005, the Bank hired an experienced SBA lender to develop an SBA lending program. The gains are attributed to the sale of the guaranteed portion of floating rate SBA loans originated by the Bank. As a result of our dynamic approach to this business line, the Bank is considered Muskegon's leading SBA lender(1), surpassing the efforts of many large banks in our market. In November 2006, the Bank opened its fourth banking facility located in Norton Shores on Harvey Street. In January 2007, the North Muskegon branch was relocated to a new building located on the Causeway in North Muskegon. Other construction in 2006, occurred in North Ottawa County in the City of Grand Haven. The Bank is constructing a larger branch in which to relocate its Grand Haven office. Completion of the Grand Haven facility is expected to occur in the third quarter of 2007. FINANCIAL CONDITION Total assets increased by $24.8 million to $247.0 million at December 31, 2006 from $222.2 million at December 31, 2005. Growth was mostly attributable to an increase in cash equivalents, loan volume and premises and equipment. Cash and cash equivalents increased by $4.4 million to $9.1 million at December 31, 2006 from $4.7 million at December 31, 2005. A majority of the increase was a result of more federal funds sold on the last day of 2006. The Bank sold $5.6 million on the last business day of December 2006 compared to federal fund sales in the amount of $.2 million on the last day of 2005. Securities held decreased by $.5 million during 2006. At year-end there were securities with a market value of $6.8 million pledged to repurchase agreements, and FHLB Advances. There were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of the Bank's shareholders' equity. As of December 31, 2006, the Bank owned seventeen municipal securities. Eight of these municipal securities were acquired in transactions that were intended to support community initiatives within Muskegon County as well as generate tax-exempt interest. Fourteen of the seventeen municipal securities owned were designated as held to maturity at the time of purchase. Loans grew 8% since year-end 2005. This rate of growth is more modest than that experienced in 2005. During 2006, the Bank was able to develop an SBA lending program, which involved the Bank originating SBA loans and selling the guaranteed portion, usually 75-80 percent of the total outstanding principal. The total principal sold related to these transactions was $2.1 million. As a result of the pursuit of this line of business the Bank may not achieve historical portfolio loan growth going forward. Portfolio loan balances were $207.4 million at December 31, 2006 up from $192.6 million at December 31, 2005. Increases to the commercial, commercial real estate, residential and consumer loan portfolios of $15.1 million were offset by a decrease in the construction portfolio of $.3 million. "Wholesale" banking continues to lead the Bank's advancement. Commercial and commercial real estate loans presently comprise 81% of the Bank's total loan portfolio, nearly the same ratio as at 2005 year-end. There are six experienced commercial lenders on staff devoted to pursuing and originating these types of loans. The $14.1 million in recorded growth was from both existing borrowers needing additional working capital and the establishment of new relationships. - ---------- (1) According to the 2006 statistics compiled by the United States Small Business Administration. 7 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS Since the loan portfolio makes up roughly 90% of the Company's earning assets, its composition is critically important from an interest rate risk standpoint. The Company attempts to mitigate interest rate risk in its loan portfolio in many ways. Two of the methods used are to balance the rate sensitivity of the portfolio and to avoid extension risk. At December 31, 2006, there were 53% of the loan balances carrying a fixed rate and 47% a floating rate. Since December 31, 2005, the proportion of fixed rate loans in the portfolio increased 8%. The main reason for this change is the fact that the Bank's internal prime rate increased four times during 2006, causing customers, existing and new, to migrate more towards fixed rate loans. The shift in the distribution resulted in an additional $22.2 million fixed rate loans, more than the total net growth recorded in 2006. The internal prime lending rate has been stable since June 2006. Based on recent economic indicators it is likely that following this period of rate stability there could be a decline in the lending rates going forward. An increase in fixed rate loans would be helpful in a declining rate environment; however, both types of loans may be useful to protect net interest income from being adversely affected by interest rate fluctuations. Management strives to optimize the repricing mix in an effort to protect the earnings of the Company. Avoidance of extension risk is the other important means to mitigate interest rate risk. In periods of low interest rates it is generally not advantageous for a financial institution to book long-term, fixed rate notes. The maturity distribution of the Bank's loan portfolio was relatively balanced between short-term (less than one year) and long-term (greater than one year) maturities at December 31, 2006. The contractual loan maturities and rate sensitivity of the loan portfolio at December 31, 2006 have been included below:
Within Three to Three Twelve One to After Months Months Five Years Five Years Total ----------- ----------- ------------ ----------- ------------ Commercial, financial and other $14,757,746 $39,135,577 $ 33,923,014 $ 2,480,722 $ 90,297,059 Real estate - commercial 9,039,790 13,597,913 55,322,724 52,138 78,012,565 Real estate-construction 829,881 504,395 0 0 1,334,276 Real estate-mortgages 62,808 209,442 1,299,445 8,600,626 10,172,321 Installment loans to individuals 1,242,725 4,749,638 19,875,955 1,747,837 27,616,155 ----------- ----------- ------------ ----------- ------------ $25,932,950 $58,196,965 $110,421,138 $12,881,323 $207,432,376 =========== =========== ============ =========== ============ Loans at fixed rates $ 6,497,916 $ 8,394,159 $ 86,626,016 $ 8,305,383 $109,823,474 Loans at variable rates 19,435,034 49,802,806 23,795,122 4,575,940 97,608,902 ----------- ----------- ------------ ----------- ------------ $25,932,950 $58,196,965 $110,421,138 $12,881,323 $207,432,376 =========== =========== ============ =========== ============
Another facet of the Company's risk management program is reduction of credit risk, the risk of nonpayment. Avoiding portfolio concentrations in any one type of loan or in a specific industry helps to decrease credit risk; however, the risk of nonpayment for any reason exists with respect to all loans. The Bank recognizes that credit losses will be experienced and will vary with, among other things, general economic conditions; the creditworthiness of the borrower over the term of the loan; and in the case of a collateralized loan, the quality of the collateral. The allowance for loan losses represents the Bank's estimate of the reserve necessary to provide for probable incurred losses in the portfolio. As such, the loan portfolio is reviewed and analyzed on a monthly basis for the purpose of estimating loan losses. The allowance is adjusted accordingly to maintain an adequate level to absorb loan losses given the risk characteristics of the loan portfolio. In making this determination, the Bank analyzes the ultimate collectibility of the loans in its portfolio by incorporating feedback provided by the Chief Lending Officer, an independent loan review and information provided by examinations performed by regulatory agencies. 8 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS At December 31, 2006, the allowance for loan losses totaled $2.5 million. The analysis of the allowance for loan losses is comprised of two portions: specific credit allocations and subjective credit allocations. The specific credit allocation includes a detailed review of a credit resulting in an allocation being made to the allowance. Subjective credit allocations are made to various categories of loans based on loan ratings, delinquency trends, historical loss experience as well as current economic conditions. Included in the subjective credit allocations is an allocation for the total balance of the unguaranteed portion of SBA loans in the Bank's loan portfolio. In general the Bank has made a decision to reserve at a higher level due to the nature and characteristics of this category of loans. Since SBA lending is a developing business initiative for the Bank it is likely that the total balance of the unguaranteed portion of SBA loans will increase in the future. The ratio of allowance to gross loans outstanding decreased to a level of 1.23% since year-end 2005. At December 31, 2005, the allowance contained $347,000 in allocations both specific and subjective for a troubled commercial relationship totaling $829,000. The allowance at December 31, 2006 contains no allocations for this particular commercial relationship. During 2006, the underlying collateral related to the commercial customer was liquidated and the appropriate charge-offs were made reducing the allowance for loan losses. The total of all allocations included in the allowance by loan class at December 31, 2006 and 2005 was as follows: Balance at End of Period Applicable to:
2006 2005 --------------------- ----------------------- Percent Percent of Loans of Loans in Each in Each Category Category to Total to Total Amount Loans Amount Loans ---------- -------- ---------- -------- Commercial $1,239,909 43.5% $1,460,911(1) 44.6% Real estate - commercial 943,907 37.6 777,331 35.5 Real estate - residential 50,862 5.0 46,830 4.9 Real estate - construction 15,344 0.6 18,820 0.8 Consumer 298,994 13.3 308,689 14.2 ---------- ----- ---------- ----- Total $2,549,016 100.0% $2,612,581 100.0% ========== ===== ========== =====
The methodology used to determine the adequacy of the allowance for loan losses is consistent with prior years. Management will continue to monitor the allocation and make necessary adjustments based on portfolio concentration levels, actual loss experience and the financial condition of the borrowers. Another factor considered in the assessment of the adequacy of the allowance is the quality of the loan portfolio from a past due standpoint. Due to a variety of causes, the Bank observed a year over year decrease in overall past due and non-accrual loans of $286,000 with a majority of the decrease occurring in the 30-59 day past due category. Loans Past due:
December 31, December 31, Increase 2006 2005 (Decrease) ------------ ------------ ----------- 30-59 days $1,407,000 $2,423,000 $(1,016,000) 60-89 days 886,000 159,000 727,000 90 days and greater 730,000 379,000 351,000 Non-accrual notes 401,000 749,000 (348,000)
- ---------- (1) Includes allocations totaling $347,228 for the troubled commercial relationship mentioned above. 9 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS It is important to note that twenty percent of the aggregate total of loans 30-59 days past due at December 31, 2005 was related to the troubled commercial relationship mentioned above and that fifty-one percent of the balance had resumed a current status by January 31, 2006. The 60-89 day category increased $727,000 since year-end 2005. Nearly 22% of the total was brought current by January 31, 2007. One customer relationship, comprising 26% of the balance, has two loans in this category. The customer is in the construction business. A house secures each loan. One house is completed and sold and is in the final stages of closing at which time the Bank's loan will be paid in full. The second house is anticipated to be completed by March 2007 and will be placed for sale. The Bank believes that the underlying collateral in both cases would be sufficient to cover the borrowings if the customer defaulted. Non-accrual notes decreased $348,000 year over year. During 2006, the Bank worked through several foreclosures on property that had been in the non-accrual category at December 31, 2005. Contrary to the improvement in past due and non accrual-loans, there was a year over year increase in the ratio of net charge-offs to average loans. Net charge-offs increased $504,000 to $784,000, or .39% of average loans in 2006 compared to $280,000, or .15% of average loans in 2005. During 2006, 62 loans were charged off. The principal balances of these charge-offs aggregated $842,000, which is up from $311,000 charged off in 2005. Nearly half of the charge-offs recorded in 2006 were related to the troubled commercial relationship mentioned above which was identified in the fourth quarter of 2005. Total recoveries on loans charged off were $58,000 in 2006 compared to $31,000 in 2005. Typically recoveries are the result of the bank selling collateral and to a lesser extent payments made by the borrower. Despite the increase in the charge-off ratio, management maintains that the Bank's credit culture and collection process are sound. Bank premises and equipment increased $5.1 million to $11.0 million at December 31, 2006 from $5.9 million at December 31, 2005. Accumulated depreciation and amortization represented $2.0 million at the end of both 2006 and 2005. During 2006, significant expenditures were made on infrastructure to enhance our footprint in the Muskegon and Northern Ottawa County area. In January of 2006, the Bank began construction of its fourth banking location at Harvey and Mt. Garfield Road, in Norton Shores. The project was completed and the branch opened its doors in November of the same year. The two-story facility is a little less than 20,000 square feet and in addition to the typical branch accessories located on the first floor, the second floor houses the Bank's operations department, a customer service call center, a training facility, and various lending personnel. The cost of the building was roughly $3.1 million. Late summer of 2006, the Bank began construction on a branch for its North Muskegon banking location. The new branch is located on the Causeway in the City of North Muskegon and is slightly more than 4,000 square feet. Construction was completed at the end of December 2006. On January 5, 2007, the North Muskegon branch was relocated from its leased facility to its new location. The cost of the building was roughly $1.1 million. A majority of the cost of this project appears in the construction in progress balance on December 31, 2006. Depreciation expense will begin in the first quarter of 2007. In October 2006, the Bank finalized the purchase of vacant land located on Apple Avenue at Quarterline in the City of Muskegon. The purchase price of the property was $721,000. The intention of the Bank is to build a fifth banking location. Late in the third quarter of 2006, construction began on a new location for the Bank's Grand Haven branch, which is currently operating out of a leased facility at US-31 and Robbins Road. The lease expires at the end of August 2007. It is management's intention to relocate the Grand Haven banking office to the new branch at US-31 and Taylor prior to that time. 10 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS Furniture, fixtures and equipment balances increased by a net figure of $677,000. Early in 2006, the Bank retired approximately $316,000 of fully depreciated equipment, mostly personal computers and accessories and purchased replacement computer equipment totaling $77,000. The additional capital expenditures in this category were mainly attributable to the establishment of the new Norton Shores Branch. In 2007, further purchases will be made in conjunction with the newly constructed branches in North Muskegon and Grand Haven. Accrued interest receivable increased $255,000 between the year-end periods of 2005 and 2006. The increase was related to the increase in the loan portfolio (discussed earlier) as well as increases to the Bank's internal prime lending rate. Other assets increased $569,000 from December 31, 2005 to December 31, 2006. The largest item contributing to the change is the fluctuation in other real estate owned balances between the two period ends. At December 31, 2006 there was $414,000 in other real estate owned compared to $20,000 at December 31, 2005. Other real estate owned is comprised of properties relinquished by customers through the collection process. Currently there are four properties being held. The largest addition during the year was related to the troubled commercial customer identified in 2005. As properties are added to other real estate owned they are written down to market value based on a professional appraisal or other common means of valuation. Although, it is not the preference of the Bank to hold these properties for an extended period of time, disposition at a fair value may be more difficult given the current condition of the local real estate market. If a property is sold at a value less than it is being held in other real estate owned, further losses could result. Deposit balances were $214.3 million at December 31, 2006, up from $190.5 million held at December 31, 2005. Most deposit categories increased year over year, particularly time deposits; however, there were declines in interest bearing demand deposits and savings. Total deposit growth for 2006 was $23.8 million. Based on deposit market share reports published by the FDIC, the Bank continued its 4th place position in Muskegon County, the same position that it had in 2005. Non-interest bearing balances were $17.2 million at December 31, 2006; a year over year increase of $614,000. An increase to non-interest bearing accounts is recognized by management as one of the most effective ways to improve net interest margin. The present enhancement of the Bank's branch system is intended to drive growth in all accounts types. Interest-bearing demand accounts, consisting of both checking and money market, decreased 11.3% during the year. The combined balances were $36.3 million at December 31, 2006 and $40.9 million at year-end 2005. Checking accounts decreased $4.9 million year over year while money market balances increased $240,000. The 20.7% decrease in checking account balances is mostly from a reduction in the balances of three large public fund customers. One public fund relationship withdrew $3.9 million from their interest-bearing demand account and used the proceeds to open short-term time deposits at the Bank. Throughout 2006, time deposit rates were significantly more attractive than the rates on interest-bearing demand accounts. Another public fund customer chose to move their accounts to a large regional bank. The loss of the relationship resulted in a $527,000 reduction in interest-bearing balances between the two year-end periods. The increase in money market balances noted above is mainly the result of existing customers carrying higher balances in their accounts. Savings accounts decreased $1.3 million since 2005. The balance at December 31, 2006 was $13.1 million, down from $14.4 million. There are two products that make up total savings account balances; regular savings accounts and Premium Sweep savings. Regular savings accounts declined $1.0 million since year-end 2005 mainly from existing customers keeping less on deposit. Premium Sweep savings customer balances decreased $303,000. Although the balances decreased in Premium Sweep savings year over year, the total number of customers in this product have increased by 30%. 11 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS Time deposits overall grew $29.2 million. The increase was comprised of local time deposits increasing by $16.8 million and brokered deposits increasing by $12.4 million. Brokered deposits are time deposits received from depositors located outside of our market area and are placed with the Bank by a deposit broker. In the event that management has the opportunity to grow its loan portfolio but does not currently have the liquidity to fund the loan originations, the Bank obtains brokered deposits. At December 31, 2006, approximately 37% of the total deposits reported were brokered compared to 35% a year earlier. During 2006, the spread between the rate of liquid (non-maturing) deposits as compared to that of a time deposit (contractually bound maturity) increased as a result of competitive pressures in the marketplace. This situation enticed local depositors, especially public fund customers, to begin investing in time deposits. A portion of the growth in local time deposits came from public fund customers who were pursuing a higher rate of interest. Non-deposit funding sources at December 31, 2005 and 2006 for the Bank included repurchase agreements and FHLB advances. There were no federal funds purchased at either year end. Fluctuations in the Bank's daily liquidity position drive required purchases of federal funds. Currently the Bank has $24.5 million of available federal funds lines with various correspondent banks to support unforeseen short-term liquidity fluctuations. Repurchase agreements decreased $1.6 million from December 31, 2005 to December 31, 2006. A repurchase agreement 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. There were five fewer customers in this product between the two year-end periods. One customer was transferred into the Premium Sweep Savings product. Fewer customers and existing customers reducing their carrying balances between the two year-end periods made up the rest of the decrease. As of the end of 2006, the Bank had the same three advances totaling $6.0 million from the FHLB outstanding as was reflected at December 31, 2005. The balance consists of three separate notes, which are all putable advances. All three instruments currently have rates ranging from 5.10% to 5.99% and 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. At the current rate levels, there is a possibility that the FHLB could 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. The scheduled maturities, if the notes are not paid prior to that, are all in 2010. Subordinated debentures outstanding at December 31, 2005 and 2006 remained at $4.5 million. On December 17, 2004, the Trust, a business trust subsidiary of the Company, using the proceeds from the sale of 4,500 Cumulative Preferred Securities ("trust preferred securities") at $1,000 per security, purchased an equivalent amount ($4.5 million) of subordinated debentures from the Company. Similar to the rate on the trust preferred securities, the subordinated debentures carry a floating rate of 2.05% over the 3-month LIBOR and was initially set at 4.55125%. The stated maturity is December 30, 2034. Interest payments on the subordinated debentures are payable quarterly on March 30th, June 30th, September 30th and December 30th. The most recent payment was made on December 30, 2006. The current rate of interest is 7.41%. The subordinated debentures can be treated as tier one capital for risk-based capital purposes up to a level of 25% of the Company's capital (including the subordinated debentures). Any remaining amount is treated as tier two capital for risk-based capital purposes. The entire $4.5 million qualifies for tier one capital at the Company. The Company has a $5 million revolving line of credit with LaSalle Bank National Association ("LaSalle"). The total balance outstanding at December 31, 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 also made a payment of $200,000 using 12 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS proceeds received from employee stock option exercises. The outstanding principal bears interest at a rate of 90 basis points below LaSalle's prime lending 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 prepaid in whole or in part without any prepayment penalty. The proceeds were essentially used for the general operating expenses of the Company. In 2006, Shareholders' equity increased by a net amount of $1.6 million. Common stock rose by $275,000 from the proceeds of stock options exercised. The consolidated net income for the Company was $1.3 million. RESULTS OF OPERATIONS Net income for 2006 was $1.3 million, which was $103,000 more than the net income of $1.2 million recorded a year earlier. The difference represents a 9% increase. On a per share basis there was an improvement of $0.07, as the Company's diluted earnings per share increased from $0.82 in 2005 to $0.89 in 2006. Factors contributing to improved earnings included an increase in net interest income of $317,000 and improvement of non-interest income of $254,000 between 2005 and 2006. The Company had retained earnings of $3.0 million at December 31, 2006 compared to $1.7 million at December 31, 2005. The following table illustrates some key operating ratios for the years ended December 31, 2006 and 2005:
2006 2005 ---- ---- Return on average assets 0.57% 0.57% Return on average shareholders' equity 8.59 8.63 Average equity to average assets 6.59 6.60
For 2006, net interest income was $8.5 million compared to $8.2 million for 2005. The increase over last year represents an improvement of 4%. Interest income generated during the year was derived from the loan portfolio, the securities portfolio, interest bearing correspondent accounts and the sale of federal funds. Interest income recorded in 2006 equaled 92% of the Company's annual revenues of which the majority was from the loan portfolio. For 2006, average earning assets increased by 8% or $15.5 million and the Bank's internal prime lending rate increased four times during the year. The average internal prime lending rate rose from 6.19% in 2005 to 7.96% in 2006, increasing the average rate earned on assets by 89 basis points. As a result of more interest earning assets and higher rates, interest income improved by $3.0 million. Interest-bearing liabilities are made up of deposits, federal funds purchased, repurchase agreements, FHLB advances, notes payable and subordinated debentures. These average interest-bearing liabilities increased 9% or $16.9 million during 2006. The average rate paid increased 107 basis points year over year. As a result of both factors, the interest expense incurred on these products totaled $8.0 million for the year compared to a figure of $5.4 million for 2005. The higher cost of funds was directly related to an escalation of the portfolio rate on time deposits, the largest liability category. Year over year the average rate paid on the time deposit portfolio increased 106 basis points. In 2006, competition played a large role in the time deposit market driving rates up more quickly than increases to rates on interest bearing demand deposit products. In some cases, depositors reacted by moving money from demand deposits to time deposits, particularly time deposits with short maturities. Throughout the year, the Bank offered time deposit specials to retain and attract deposits. At December 31, 2006, the time deposit portfolio comprised 69% of total interest-bearing deposits compared to 62% in 2005. Some of the factors affecting both net interest spread and net interest margin were mentioned above, including the mix of interest-earning assets, the mix of interest-bearing liabilities and the interest rate 13 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS sensitivity of the various categories. To illustrate the Company's condition, 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 period indicated. Such yields and costs are derived by dividing income or expenses by the average daily balance of assets or liabilities, respectively, for the periods presented:
Years Ended December 31: --------------------------------------------------------------------------------- 2006 2005 --------------------------------------- --------------------------------------- Average Average Average Average Balance Interest Yield/Rate Balance Interest Yield/Rate ------------ ----------- ---------- ------------ ----------- ---------- Assets Federal funds sold and interest bearing deposits with banks $ 3,115,319 $ 144,855 4.65% $ 2,015,919 $ 62,276 3.09% Securities (1, 2) 19,371,304 843,013 4.35 18,857,818 764,305 4.05 Loans (3) 198,625,907 15,617,761 7.86 184,690,712 12,781,600 6.92 ------------ ----------- ---- ------------ ----------- ------ 221,112,530 16,605,629 7.51 205,564,449 13,608,181 6.62 Other assets 11,058,121 7,466,078 ------------ ------------ $232,170,651 $213,030,527 ============ ============ Liabilities and Shareholders' Equity Interest-bearing deposits $180,734,753 $ 7,044,480 3.90 $160,282,633 $ 4,530,508 2.83 Federal funds purchased and repurchase agreements 7,072,189 271,502 3.84 10,915,239 253,864 2.33 Subordinated debentures, notes payable and FHLB advances 10,805,218 695,864 6.44 10,500,000 592,956 5.65 ------------ ----------- ---- ------------ ----------- ------ 198,612,160 8,011,846 4.03 181,697,872 5,377,328 2.96 ------------ ----------- ----------- Noninterest-bearing deposits 17,505,342 16,457,530 Other liabilities 743,435 821,761 Shareholders' Equity 15,309,714 14,053,364 ------------ ------------ $232,170,651 $213,030,527 ============ ============ Net interest income (tax equivalent basis) 8,593,783 8,230,853 =========== =========== Net interest spread on earning assets (tax equivalent basis) 3.48% 3.66% ====== ====== Net interest margin on earning assets (tax equivalent basis) 3.89 4.00 ====== ====== Average interest-earning assets to Average interest-bearing liabilities 111.33 113.14 ====== ====== Tax equivalent adjustment 115,840 69,885 ----------- ----------- Net interest income $ 8,477,943 $ 8,160,968 =========== ===========
Although the impact of prime rate increases is positive on the interest income generated on new loan volume and many existing variable rate loan products, the rising rate environment over the past few years negatively impacted the Bank's expense to retain and attract both local and brokered deposits. As displayed in the table above, in 2006 the Bank experienced a more significant increase in rates paid on funding sources as compared to increases to rates earned on invested assets. As a result, the Company's net interest spread declined by 18 basis points, from 3.66% in 2005 to 3.48% in 2006, and the Company's net interest margin (tax equivalent) on earning assets decreased by 11 basis points. The - ---------- (1) Includes Federal Home Loan Bank Stock. (2) Adjusted to a fully tax equivalent basis. (3) Includes loans held for sale and non-accrual loans. 14 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS margin was 3.89% for the twelve months ended December 31, 2006 and 4.00% for the twelve months ended December 31, 2005. As a further demonstration of the effect of rates and volume on this outcome, below is a table displaying the change in interest income and interest expense on interest-earning assets and interest-bearing liabilities segregated between change due to volume and change due to rate:
Year ended December 31, 2006 over 2005 ------------------------------------ Total Volume Rate ---------- ---------- ---------- Increase (decrease) in interest income Federal funds sold and interest- bearing deposits with banks $ 82,579 $ 42,869 $ 39,710 Securities(1) 78,708 21,226 57,482 Loans 2,836,161 1,011,212 1,824,949 ---------- ---------- ---------- Net change in interest income 2,997,448 1,075,307 1,922,141 Increase (decrease) in interest expense Interest-bearing deposits 2,513,971 812,716 1,701,255 Federal funds purchased and repurchase agreements 17,638 (109,800) 127,438 Subordinated debentures, notes payable and FHLB advances 102,908 17,651 85,257 ---------- ---------- ---------- Net change in interest expense 2,634,517 720,567 1,913,950 ---------- ---------- ---------- Net change in net interest income $ 362,931 $ 354,740 $ 8,191 ========== ========== ==========
Net interest margin compression was a factor in 2006 as anticipated. The lag in deposit rate increases, which benefited the Company in the past two years, had a detrimental effect on the net interest margin once increases to the internal prime lending rate ceased. Based on the current condition of the economy, management believes that the national federal funds rate, which drives the Bank's internal prime lending rate, is likely to remain stable for a large portion of 2007. Any future movements are anticipated to be decreases from the current level of 8.25%. Further net interest margin compression is anticipated in 2007 as $106.3 million in time deposits are repricing during the year. The provision for loan losses was $721,000 for 2006 compared to $854,000 for 2005. The 2006 expense was significantly impacted by greater loan charge-off activity during the year. The expense in 2005 was adversely impacted by a troubled commercial relationship, identified in the fourth quarter of that year, requiring an increase in allocated loan losses in the allowance related to these credits. Management continues 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. Management believes that the allowance level is adequate and justifiable based on the factors discussed earlier (see Financial Condition). Non-interest income recorded in 2006 was $1.5 million, which reflects a $254,000 increase since 2005. The 20% increase was largely related to increased gains on loan sales. The gains were from the sale of the guaranteed portion of SBA loans. Late in 2005, the Bank hired an experienced SBA lender to develop an SBA lending program. The gains reflected in the 2006 results are attributed to the sale of the guaranteed portion, typically 75% to 80% of - ---------- (1) Adjusted to a fully tax equivalent basis. 15 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS the total principal, of saleable SBA loans originated by the Bank. As a result of our aggressive approach to this new initiative, $188,000 in gains were recorded in the second half of 2006. In the past, gains on loan sales came solely from the mortgage area. Ignoring the effect of the SBA initiative, mortgage-related gains were pretty flat for the twelve-month periods of 2005 and 2006. It is not surprising that mortgage-related loan gains are stagnant given the condition of the state's economy and the corresponding softness of the state's real estate market. Nonetheless, management is optimistic about future revenue from both SBA and mortgage-related loan sales. The mortgage loan optimism stems from additional resources and a new market territory. The Mortgage Company hired an additional originator in the fourth quarter of 2006 to cover customer needs at the Harvey Street Branch. For the year, non-interest expenses were $7.4 million, an increase of 9% over 2005. Salaries and benefits differences comprised $201,000 of the year over year increase. There were 11 more full-time equivalent employees at December 31, 2006 compared to December 31, 2005. A majority of the additional staff were connected with the opening of a fourth banking location. Along with the staff additions, there were annual salary adjustments and increased benefit costs. Although two existing branch locations are being relocated to larger facilities in 2007, very few new positions are anticipated for these two branches. The greater part of the aforementioned full-time additions will likely be in the lending and operations areas. Furniture, equipment and occupancy expenses increased $128,000 between 2005 and 2006. Maintenance contracts on equipment rose $22,000 since 2005. Property tax expenses for the land purchases made over the last two years and additional building insurance for the construction projects added $32,000 to the totals. There was $35,000 of associated expenses for terminating our North Muskegon lease early. Since the branch in Norton Shores did not open until November there was not a huge impact on overall depreciation expenses. There was $29,000 of additional depreciation recorded in the last quarter of 2006 attributable to the Harvey Street Branch. Depreciation expense will rise significantly in 2007 as a result of the opening of the North Muskegon and Grand Haven locations as well as twelve full months of the Norton Shores facility. One offsetting factor to the depreciation will be the elimination of rental expense. Advertising expenses increased $86,000, or 61% in 2006. The Bank continued its image campaign, instituted in 2005, throughout the local marketplace utilizing billboards, television commercials and other media. A major topic of the media blitz was the new locations and the new staff. In 2007, the Bank intends on continuing its active marketing campaign including additional expenses for the promotion of our North Muskegon and Grand Haven locations. Data processing increased $20,000. The modest increase is the result of a contract renegotiation with the Bank's third-party data processor in July of 2006. The lower fee structure helped offset higher transaction volume due to general growth in both the loan and deposit customer base. Professional services expense increased $64,000 since 2005. There was a marked increase in legal expenses in 2006. In addition to the legal counseling received for personnel matters, the Bank defended its position in several lawsuits with customers. Lawsuits of this nature are deemed incidental to the banking business. There have been no contingent liabilities accrued in relation to any of the legal proceedings. Other operating expenses increased 8% or $106,000. There are two sources that are mainly responsible for the increase in this total, loan collection expenses and miscellaneous losses. Each are explained below. In 2006, the Bank recorded higher loan collection expenses. The increase was $61,000 between 2005 and 2006. As there were more problem loan issues encountered, especially the foreclosed properties discussed earlier (Financial Condition), and higher charged-off loan totals, it is reasonable that there would be higher expenses in this area. Expenses of this nature are expected and ongoing. 16 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS The Bank incurred a loss on a local debit card fraud incident occurring in November of 2006. A local vendor experienced a security breach in its system which was illicitly housing debit card transaction information. The breach resulted in thousands of debit card numbers being used for fraudulent charges. The losses affected most banks and credit unions in the area, not just the Bank. The Bank's losses were approximately $58,000. In the fourth quarter, $50,000 of the total was charged to miscellaneous losses and an insurance claim was submitted for the remaining portion. The amount charged off is essentially the insurance deductible for claims of this nature. As debit and credit card crimes are escalating throughout the world, the Bank continues to assess its procedures for handling fraud alerts. A due amount of care is given to each situation concerning both customer impact and potential Bank losses. The Company had a consolidated federal tax expense of $569,000 in 2006, 30% of its earnings. For 2005, the Company had a consolidated federal tax expense of $572,000, 32% of its earnings. The Bank was able to reduce its federal tax expense by increasing its holdings of tax-exempt municipal securities. It is anticipated that the concentration of these types of municipal holdings within the Bank's investment portfolio will remain the same or increase slightly. As a result, future earnings of the Company are anticipated to be taxable at a rate below 34%. LIQUIDITY AND INTEREST RATE SENSITIVITY The Company's Asset Liability Committee ("ALCO"), which includes senior management and the Bank's Controller, and Assistant Controller monitors and manages liquidity and interest rate risk. ALCO reports to the Board of Directors and operates within Board approved policy limits. 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. In addition to normal loan funding and deposit flow, the Bank needs to maintain liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit. At December 31, 2006, the Bank had a total of $37.3 million in unfunded loan commitments and $2.6 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $39.1 million were commitments available as lines of credit to be drawn at any time as customers' cash needs vary, and $0.8 million were for loan commitments scheduled to close and become funded within the next month. The bank monitors fluctuations in loan balances and commitment levels, and includes such data in overall liquidity management. As of December 31, 2006, the Bank had $24.5 million of established federal funds purchase lines through its correspondent banks. Although the Bank strives to be a seller of federal funds it recognizes the importance of the established lines in times of unexpected activity. Given the annual asset growth of the Bank, it is prudent to periodically seek increases to this funding source. The Bank increased its available credit under federal funds purchased lines by $4.5 million in 2006. A second source of liquidity is the FHLB of Indianapolis and its various borrowing programs. The Bank has been a member since purchasing stock late in 1999 and has secured Board approval to borrow up to $20.0 million. Currently the Bank has FHLB advances of $6.0 million outstanding. All FHLB borrowings require the Bank to pledge collateral consisting of either real estate loans or high quality government securities. Additional advances are limited to the amount of collateral available to pledge. At December 31, 2006, there were securities with a market value of $5.7 million but no additional qualified residential real estate loans available to pledge. Another viable collateral source within the Bank's loan portfolio is its pool of commercial real estate loans. At December 31, 2006 the balance of the commercial real estate portfolio was $78.0 million. However, due to the strict FHLB guidelines related to pledging these types of loans, the Bank has not chosen to actively pursue pledging commercial real estate loans. A third way to adjust liquidity is by using established deposit brokers to purchase out-of area deposits (brokered certificates of deposits) and arrange large block settlements through the Depository Trust 17 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS Company. The concentration of brokered deposits to total deposits was 37% at December 31, 2006, up from 35% at December 31, 2005. Brokered deposits increased by $12.4 million in 2006. The Bank has an internal policy that limits the concentration of brokered deposits to total deposits. The maximum concentration level is 50% under the internal policy. The branching strategy in process is intended to increase local deposits and decrease the concentration of brokered deposits, making this funding source more useful in the future. Finally, the Bank applied to Chicago's Federal Reserve Bank for authorization to borrow from its Discount Window and is in the process of satisfying the remaining qualifications. The Federal Reserve Discount Window Primary Credit borrowing program is another short term funding option. The program would entail pledging securities as collateral for borrowings. It is management's intention to pledge the Bank's portfolio of municipal securities to support future borrowings. Currently there are $5.9 million of municipal holdings in the investment portfolio. Primary Credit borrowings are typically at a rate above the Federal Open Market Committee's target rate for federal funds, which is currently 5.25%. Another important responsibility of the ALCO is to monitor interest rate risk. Interest rate risk is the exposure to adverse changes in net interest income due to changes in interest rates. The Company employs a variety of measurement techniques to identify and manage this risk. A sophisticated simulation model is used to analyze net interest income sensitivity. The model incorporates both actual cash flows and contractual repricing behavior as well as economic and market based assumptions provided by senior management. ALCO strives to maintain a balance between interest-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 rate 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. 18 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS Details of the Bank's repricing gap at December 31, 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 $ 72,115 $ -- $ -- $ -- $ 72,115 Federal funds sold 5,600,000 -- -- -- 5,600,000 Securities (including FHLB stock) 1,733,549 1,443,609 9,239,736 6,429,478 18,846,372 Loans 107,617,762 15,353,956 78,689,056 5,936,672 207,597,446 ------------ ------------ ----------- ----------- ------------ 115,023,426 16,797,565 87,928,792 12,366,150 232,115,933 Interest-bearing liabilities Savings and checking 49,368,113 -- -- -- 49,368,113 Time deposits <$100,000 10,335,992 19,298,535 9,523,783 -- 39,154,246 Time deposits >$100,000 31,773,098 44,845,673 31,958,136 -- 108,580,971 Repurchase agreements and Federal funds purchased 4,494,614 -- -- -- 4,494,614 Notes payable and Federal Home Loan Bank advances 10,900,000 -- -- -- 10,900,000 ------------ ------------ ----------- ----------- ------------ 106,871,817 64,144,208 41,481,919 -- 212,497,944 Net asset (liability) repricing gap $ 8,151,609 $(47,346,643) $46,446,873 $12,366,150 $ 19,617,989 ============ ============ =========== =========== ============ Cumulative net asset (liability) repricing gap $ 8,151,609 $(39,195,034) $ 7,251,839 $19,617,989 ============ ============ =========== ===========
The interest rate sensitivity table simply illustrates what the Company is contractually able to change in certain time frames. 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 December 31, 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, given the deposit repricing lag discussed earlier. Throughout 2006, both local and brokered deposit rates rose significantly. ALCO is continually challenged to develop methods for balancing this gap and managing interest rate sensitivity. CAPITAL RESOURCES The Company and the 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. In general, capital amounts and classifications are subject to qualitative judgments by regulators about components, risk weighting, 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. 19 COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS As a general practice, the Bank will seek to maintain a total risk-based capital ratio of above 10%. At this level, the Bank will have reduced FDIC insurance premiums and will be allowed to continue its use of brokered deposits. The Bank's management carefully monitors this ratio and intends to obtain capital for infusion into the Bank as necessary to maintain the 10% level. The total risk-based capital ratios of the Company and the Bank at December 31, 2006 were 10.37% and 10.45%, respectively. During 2006, the Company contributed no capital into the Bank. The Bank's earnings were enough to support its growth of risk-based assets and maintain its total risk based capital ratio at a level above 10%. In 2007 as the two new branches are added, the Bank's risk-based asset totals will increase; however, the Bank's earnings will be negatively affected by an increase in depreciation expense. The Company may need to contribute capital. The Company believes that it has sufficient resources to infuse the necessary capital for the Bank to maintain its well-capitalized position in 2007. The main resource available to the Company at this time is a $5.0 million revolving line of credit with LaSalle. The current outstanding balance on the line of credit is $400,000. There are no immediate plans for additional capital raising by the Company at this time. RECENT ACCOUNTING DEVELOPMENTS In September 2006, the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), which is effective for fiscal years ending on or after November 15, 2006. SAB 108 provides guidance on how effects of prior-year uncorrected financial statement misstatements should be considered in quantifying a current year misstatement. SAB 108 requires public companies to quantify misstatements using both an income statement (rollover) and balance sheet (iron curtain) approach and evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. If prior year errors that had been previously considered immaterial now are considered material based on either approach, no restatement is required so long as management properly applied its previous approach and all relevant facts and circumstances were considered. Adjustments considered immaterial in prior years under all relevant facts and circumstances were considered. Adjustments considered immaterial in prior years under the method previously used, but now considered material under the dual approach required by SAB 108, are to be recorded upon initial adoption of SAB 108. The adoption of SAB 108 had no effect on the Company's financial statements for the year ending December 31, 2006. Effect of Newly Issued But Not Yet Effective Accounting Standards: New accounting standards have been issued that the Company does not expect will have a material effect on the financial statements when adopted in future years or for which the Company has not yet completed its evaluation of the potential effect upon adoption. In general, these standards revise the accounting for derivatives embedded in other financial instruments for 2007, revise the recognition and accounting for servicing of financial assets for 2007, establish a hierarchy about the assumptions used to measure fair value for 2008, revise the accrual of post-retirement benefits associated with providing life insurance for 2008, and revise the accounting for cash surrender value for 2007. In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (FIN 48), which prescribes a recognition threshold and measurement attribute 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 determined that the adoption of FIN 48 will not have a material effect on the financial statements. 20 (CROWE(TM) LOGO) REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Shareholders Community Shores Bank Corporation Muskegon, Michigan We have audited the accompanying consolidated balance sheets of Community Shores Bank Corporation as of December 31, 2006 and 2005 and the related consolidated statements of income, changes in shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Community Shores Bank Corporation as of December 31, 2006 and 2005, and the results of its operations and its cash flows for the years then ended in conformity with U.S. generally accepted accounting principles. Crowe Chizek and Company LLC Grand Rapids, Michigan March 14, 2007 21 COMMUNITY SHORES BANK CORPORATION CONSOLIDATED BALANCE SHEETS December 31, 2006 and 2005
2006 2005 ------------- ------------- ASSETS Cash and due from financial institutions $ 3,398,155 $ 4,361,277 Interest-bearing deposits in other financial institutions 72,115 90,182 Federal funds sold 5,600,000 200,000 ------------ ------------ Cash and cash equivalents 9,070,270 4,651,459 Securities Available for sale (at fair value) 13,184,437 13,983,933 Held to maturity (fair value of $5,219,555 and $4,822,327 at December 31, 2006 and 2005, respectively) 5,257,835 4,918,499 ------------ ------------ Total securities 18,442,272 18,902,432 Loans held for sale 165,070 -- Loans 207,432,376 192,644,742 Less: Allowance for loan losses 2,549,016 2,612,581 ------------ ------------ Net loans 204,883,360 190,032,161 Federal Home Loan Bank stock 404,100 425,000 Premises and equipment, net 10,958,821 5,922,886 Accrued interest receivable 1,249,680 994,219 Other assets 1,807,258 1,238,194 ------------ ------------ Total assets $246,980,831 $222,166,351 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Deposits Noninterest-bearing $ 17,179,082 $ 16,564,735 Interest-bearing 197,103,330 173,886,366 ------------ ------------ Total deposits 214,282,412 190,451,101 Federal funds purchased and repurchase agreements 4,494,614 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 -- Accrued expenses and other liabilities 1,185,180 650,329 ------------ ------------ Total liabilities 230,862,206 207,666,440 Shareholders' equity Preferred stock, no par value 1,000,000 shares authorized, none issued -- -- Common stock, no par value; 9,000,000 shares authorized 1,466,800 and 1,436,800 shares issued and outstanding 13,274,098 12,998,670 Retained earnings 3,027,774 1,712,462 Accumulated other comprehensive loss (183,247) (211,221) ------------ ------------ Total shareholders' equity 16,118,625 14,499,911 ------------ ------------ $246,980,831 $222,166,351 ============ ============
See accompanying notes to consolidated financial statements. 22 COMMUNITY SHORES BANK CORPORATION CONSOLIDATED STATEMENTS OF INCOME Years ended December 31, 2006 and 2005
2006 2005 ------------ ----------- Interest and dividend income Loans, including fees $15,617,761 $12,781,600 Securities, taxable 517,999 567,526 Securities, tax-exempt 209,174 126,894 Federal funds sold, FHLB dividends and other income 144,855 62,276 ----------- ----------- Total interest and dividend income 16,489,789 13,538,296 Interest expense Deposits 7,044,480 4,530,508 Repurchase agreements, federal funds purchased, and other debt 271,502 253,864 Federal Home Loan Bank advances and notes payable 695,864 592,956 ----------- ----------- Total interest expense 8,011,846 5,377,328 ----------- ----------- NET INTEREST INCOME 8,477,943 8,160,968 Provision for loan losses 720,701 853,728 ----------- ----------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 7,757,242 7,307,240 Non-interest income Service charges on deposit accounts 955,488 929,258 Mortgage loan referral fees 2,812 9,102 Gain on sale of loans 211,813 22,099 Gain on sale of mortgage servicing rights -- 3,088 Gain on disposal of equipment (124) 11,925 Other 347,436 287,667 ----------- ----------- Total non-interest income 1,517,425 1,263,139 Non-interest expense Salaries and employee benefits 3,999,457 3,798,599 Occupancy 397,185 319,623 Furniture and equipment 434,519 384,070 Advertising 226,688 140,373 Data processing 381,035 360,912 Professional services 539,521 475,153 Other 1,412,193 1,306,541 ----------- ----------- Total non-interest expense 7,390,598 6,785,271 ----------- ----------- INCOME BEFORE FEDERAL INCOME TAXES 1,884,069 1,785,108 Federal income tax expense 568,757 572,427 ----------- ----------- NET INCOME $ 1,315,312 $ 1,212,681 =========== =========== Weighted average shares outstanding 1,447,485 1,434,185 =========== =========== Diluted average shares outstanding 1,478,168 1,471,939 =========== =========== Basic earnings per share $ 0.91 $ 0.85 =========== =========== Diluted earnings per share 0.89 0.82 =========== ===========
See accompanying notes to consolidated financial statements. 23 COMMUNITY SHORES BANK CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY December 31, 2006 and 2005
Accumulated Other Total Common Retained Comprehensive Shareholders' Shares Stock Earnings Income (Loss) Equity --------- ----------- ---------- ------------- ------------- BALANCE AT JANUARY 1, 2005 1,430,000 $12,922,314 $ 499,781 $ (22,763) $13,399,332 Proceeds from the exercise of stock options 6,800 69,604 69,604 Tax benefit from stock option exercises 6,752 6,752 Comprehensive income: Net income 1,212,681 1,212,681 Unrealized loss on securities available for sale, net (188,458) (188,458) ----------- Total comprehensive income 1,024,223 --------- ----------- ---------- --------- ----------- BALANCE AT DECEMBER 31, 2005 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 options exercises (10,000) (125,900) (125,900) Stock option compensation expense 1,328 1,328 Comprehensive income: Net income 1,315,312 1,315,312 Unrealized gain on securities available for sale, net 27,974 27,974 ----------- Total comprehensive income 1,343,286 --------- ----------- ---------- --------- ----------- BALANCE AT DECEMBER 31, 2006 1,466,800 $13,274,098 $3,027,774 $(183,247) $16,118,625 ========= =========== ========== ========= ===========
See accompanying notes to consolidated financial statements. 24 COMMUNITY SHORES BANK CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 2006 and 2005
2006 2005 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 1,315,312 $ 1,212,681 Adjustments to reconcile net income to net cash from operating activities: Provision for loan losses 720,701 853,728 Depreciation and amortization 315,340 301,812 Net amortization (accretion) of securities 25,925 33,044 Net realized gain on sale of loans (211,813) (22,099) Net realized gain on disposition of equipment 124 (11,925) Originations of loans for sale (4,208,637) (2,868,250) Proceeds from loan sales 4,255,380 2,890,349 Stock option compensation expense 1,328 -- Tax benefit from stock option exercises -- 6,752 Net change in: Accrued interest receivable and other assets (1,263,659) (366,933) Accrued interest payable and other liabilities 534,851 (151,646) ------------ ------------ Net cash from operating activities 1,484,852 1,877,513 CASH FLOWS FROM INVESTING ACTIVITIES Activity in available for sale securities: Maturities, pre-payments and calls 4,053,680 2,234,298 Purchases (3,224,798) -- Activity in held to maturity securities: Maturities 185,000 155,000 Purchases (537,262) (4,679,975) Loan originations and payments, net (15,147,177) (21,425,628) Redemption of Federal Home Loan Bank Stock 20,900 -- Proceeds from the disposal of equipment -- 15,000 Additions to premises and equipment, net (5,351,399) (3,684,778) ------------ ------------ Net cash from investing activities (20,001,056) (27,386,083) CASH FLOWS FROM FINANCING ACTIVITIES Net change in deposits 23,831,311 31,630,578 Net change in federal funds purchased and repurchase agreements (1,570,396) (3,915,768) Other borrowing activity: Draws on notes payable and line of credit 600,000 -- Paydowns on notes payable and line of credit (200,000) -- Net proceeds from exercises of stock options 274,100 69,604 ------------ ------------ Net cash used in financing activities 22,935,015 27,784,414 Net change in cash and cash equivalents 4,418,811 2,275,844 Beginning cash and cash equivalents 4,651,459 2,375,615 ------------ ------------ ENDING CASH AND CASH EQUIVALENTS $ 9,070,270 $ 4,651,459 ============ ============ Supplemental cash flow information: Cash paid during the period for interest $ 7,976,456 $ 5,430,370 Cash paid during the period for federal income tax 520,000 785,000 Transfers from loans to foreclosed assets 424,723 48,257
See accompanying notes to consolidated financial statements. 25 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of Community Shores Bank Corporation (the "Company") and its wholly-owned subsidiaries, Community Shores Financial Services ("CS Financial Services"), and Community Shores Bank (the "Bank"), and the Bank's wholly owned subsidiary, Community Shores Mortgage Company (the "Mortgage Company"), after elimination of significant intercompany transactions and accounts. NATURE OF OPERATIONS: The Company was incorporated on July 23, 1998 under Michigan law and is a financial holding company owning all of the common stock of the Bank. The Bank is a Michigan banking corporation with depository accounts insured by the Bank Insurance Fund of the Federal Deposit Insurance Corporation (the "FDIC"). The Bank provides a range of commercial and consumer banking services in West Michigan, primarily in Muskegon County, which includes the cities of Muskegon and North Muskegon, and Northern Ottawa County, which includes the city of Grand Haven. Those services reflect the Bank's strategy of serving small to medium-sized businesses, and individual customers in its market area. Services for businesses include commercial loans and traditional business accounts. Management focuses the Bank's retail banking strategy on providing traditional banking products and services, including automated teller machines, computer banking, telephone banking and automated bill-paying services to individuals and businesses in the Bank's market area. The Bank began operations on January 18, 1999. The Mortgage Company, a wholly-owned subsidiary of the Bank, was formed on March 1, 2002 by transferring a majority of the Bank's commercial and residential real estate loans in exchange for 100% of the equity capital of the Mortgage Company. On the day that the Mortgage Company commenced operations it began originating residential mortgage loans with the intent to sell them to a third party for a profit. The Bank services all of the portfolio loans held by the Mortgage Company pursuant to a servicing agreement. Management chose to form the Mortgage Company to provide better customer service and to increase the profitability of the mortgage function as well as the consolidated Company. The Company filed an election to become a financial holding company pursuant to Title I of the Gramm-Leach-Bliley Act and on September 27, 2002 received regulatory approval. At that time the Company formed CS Financial Services. Prior to 2005, CS Financial Services held a 1.86% ownership interest in the Michigan Bankers Insurance Center, LLC. In April of 2005, the partnership was legally dissolved. Currently the only source of revenue that CS Financial Services receives is referral fee income from a local insurance agency, Lakeshore Employee Benefits, formerly Lead Financial. Lakeshore Employee Benefits offers, among other things, employer-sponsored benefit plans. CS Financial Services has the opportunity to earn a referral fee for each sale of employer-sponsored benefits that is transacted by Lakeshore Employee Benefits as a result of a referral made by CS Financial Services. Community Shores Capital Trust I, ("the Trust") was formed in December 2004. The Company owns all of the common securities of this special purpose trust. The Trust is not consolidated and exists solely to issue capital securities. USE OF ESTIMATES: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The primary estimates incorporated into the Company's consolidated financial statements, which are susceptible to change in the near term, include the allowance for loan losses and the fair value of financial instruments. CASH FLOW REPORTING: Cash and cash equivalents includes cash, demand deposits with other financial institutions, short-term investments (securities with daily put provisions) and federal funds sold. Cash flows are reported net for customer loan and deposit transactions, interest-bearing time deposits with other financial institutions and short-term borrowings with maturities of 90 days or less. 26 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) SECURITIES: Securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income. Other securities such as FHLB stock are carried at cost. Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level yield method without anticipating prepayments. Gains and losses on sales are based on the amortized cost of the security sold. Declines in the fair value of securities below their cost that are other than temporary are reflected in realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the Company's ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value. LOANS: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs, and an allowance for loan losses. Loans held for sale are reported at the lower of cost or market, on an aggregated basis. Loans sold to outside investors are sold servicing released. There were loans totaling $165,070 for sale at December 31, 2006 but no loans held for sale at December 31, 2005. Interest income is accrued on the unpaid principal using the interest method assigned to the loan product and includes amortization of net deferred loan fees and costs over the loan term. Interest income is not reported when full loan repayment is in doubt, typically when the loan is impaired or payments are past due over 90 days (180 days for residential mortgages). Consumer and credit card loans are typically put on non-accrual status or charged off no later than 120 days past due. All interest accrued but not received for loans placed on non-accrual is reversed against interest income at the time the loan is assigned non-accrual status. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required using past industry and historical loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged off. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors. 27 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. TRANSFERS OF FINANCIAL ASSETS: Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. FORECLOSED ASSETS: Assets acquired through or instead of loan foreclosure are initially recorded at fair value when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. PREMISES AND EQUIPMENT: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 40 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 7 years. LONG-TERM ASSETS: Premises and equipment and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value. REPURCHASE AGREEMENTS: Substantially all repurchase agreement liabilities represent amounts advanced by various customers. These balances are not deposits and are not covered by federal deposit insurance. Securities are pledged to cover these liabilities. STOCK COMPENSATION: Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 123(R), Share-based Payment, using the modified prospective transition method. Accordingly, the Company has recorded stock-based employee compensation cost using the fair value method starting in 2006. For 2006, adopting this standard resulted in a reduction of income before taxes of $1,779, and a reduction in net income of $1,328. There was no effect on basic or diluted earnings per share because of the insignificance of the expense relative to the basic and diluted shares outstanding. Prior to January 1, 2006, employee compensation expense under stock options was reported using the intrinsic value method; therefore, no stock-based compensation cost is reflected in net income for the year ending December 31, 2005, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. The following table illustrates the effect on the net income and the earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123 Accounting for Stock-Based Compensation for the year ending December 31, 2005: 28 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
2005 ---------- Net income as reported $1,212,681 Deduct: stock-based compensation expense determined under fair value based method (net of taxes) 139,923 Amount expensed in period (net of taxes) -- ---------- Pro forma net income $1,072,758 Basic earnings per share as reported $ 0.85 Pro forma basic earnings per share 0.75 Diluted earnings per share as reported 0.82 Pro forma diluted earnings per share 0.73
INCOME TAXES: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Standby letters of credit are considered guarantees in accordance with FASB Interpretation No. 45 and are recorded at fair value. EARNINGS PER COMMON SHARE: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options. In 2006, the dilutive effect of options outstanding added an additional 30,683 shares to the diluted earnings per share calculation. In 2005, they added 37,754 additional shares. In 2006, stock options for 18,000 shares of common stock were not considered in computing diluted earnings per share because they were anti-dilutive. COMPREHENSIVE INCOME: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale, which are also recognized as separate components of equity. LOSS CONTINGENCIES: Loss contingencies, including claims and legal actions arising in the ordinary course of business are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Currently, management does not believe there now are such matters that will have a material effect on the financial statements. RESTRICTIONS ON CASH: The Bank was required to have $829,000 of cash on hand, or on deposit, with the Federal Reserve Bank to meet regulatory reserve and clearing requirements at year-end 2006. These balances do not earn interest. The requirement at year-end 2005 was $968,000. DIVIDEND RESTRICTIONS: The Company and the Bank are subject to banking regulations which require the maintenance of certain capital levels and positive retained earnings and may limit the amount of dividends thereafter. 29 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) FAIR VALUE OF FINANCIAL INSTRUMENTS: Fair value of financial instruments is estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, pre-payments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. EFFECT OF NEW ACCOUNTING STANDARDS: In September 2006, the Securities Exchange Commission (SEC) released Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), which is effective for fiscal years ending on or after November 15, 2006. SAB 108 provides guidance on how effects of prior-year uncorrected financial statement misstatements should be considered in quantifying a current year misstatement. SAB 108 requires public companies to quantify misstatements using both an income statement (rollover) and balance sheet (iron curtain) approach and evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. If prior year errors that had been previously considered immaterial now are considered material based on either approach, no restatement is required so long as management properly applied its previous approach and all relevant facts and circumstances were considered. Adjustments considered immaterial in prior years under all relevant facts and circumstances were considered. Adjustments considered immaterial in prior years under the method previously used, but now considered material under the dual approach required by SAB 108, are to be recorded upon initial adoption of SAB 108. The adoption of SAB 108 had no effect on the Company's financial statements for the year ending December 31, 2006. EFFECT OF NEWLY ISSUED BUT NOT YET EFFECTIVE ACCOUNTING STANDARDS: New accounting standards have been issued that the Company does not expect will have a material effect on the financial statements when adopted in future years or for which the Company has not yet completed its evaluation of the potential effect upon adoption. In general, these standards revise the accounting for derivatives embedded in other financial instruments for 2007, revise the recognition and accounting for servicing of financial assets for 2007, establish a hierarchy about the assumptions used to measure fair value for 2008, revise the accrual of post-retirement benefits associated with providing life insurance for 2008, and revise the accounting for cash surrender value for 2007. In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (FIN 48), which prescribes a recognition threshold and measurement attribute 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 determined that the adoption of FIN 48 will not have a material effect on the financial statements. INDUSTRY SEGMENTS: While Management monitors the revenue streams of the various products and services, the identifiable segments are not material and operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the financial service operations are considered to be aggregated in one reportable segment. RECLASSIFICATION: Some items in the prior year financial statements were reclassified to conform to the current presentation. 30 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 - SECURITIES The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:
Gross Gross Unrealized Unrealized Fair Gains Losses Value ---------- ---------- ----------- Available for Sale 2006 - ---- US Government and federal agency $ 6,015 $(108,742) $ 4,408,178 Municipals 4,500 (2,778) 707,516 Mortgage-backed 5,452 (182,094) 8,068,743 ------- --------- ----------- $15,967 $(293,614) $13,184,437 ======= ========= ===========
Gross Gross Unrealized Unrealized Fair Gains Losses Value ---------- ---------- ----------- Available for Sale 2005 - ---- US Government and federal agency $ -- $(166,450) $ 5,360,898 Municipals 6,009 (7,928) 706,641 Mortgage-backed 5,953 (157,616) 7,916,394 ------- --------- ----------- $11,962 $(331,994) $13,983,933 ======= ========= ===========
There were no dispositions of available for sale securities in 2006 or 2005. The carrying amount, unrecognized gains and losses and fair value of securities held to maturity were as follows:
Gross Gross Carrying Unrecognized Unrecognized Fair Held to Maturity Amount Gains Losses Value - ---------------- ---------- ------------ ------------ ---------- 2006 - ---- Municipals $5,257,835 $2,552 $(40,832) $5,219,555 ========== ====== ======== ========== 2005 - ---- Municipals $4,918,499 $2,327 $(98,499) $4,822,327 ========== ====== ======== ==========
31 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 - SECURITIES (Continued) The fair value of debt securities and carrying amount, if different, at year-end 2006 by contractual maturity were as follows. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately:
Available Held to Maturity for sale ----------------------- ----------- Carrying Fair Value Amount Fair Value ----------- ---------- ---------- Due in one year or less $ 1,360,927 $ -- $ -- Due from one to five years 3,158,074 1,170,028 1,166,725 Due in more than five years 596,693 4,087,807 4,052,830 Mortgage-backed 8,068,743 -- -- ----------- ---------- ---------- $13,184,437 $5,257,835 $5,219,555 =========== ========== ==========
Securities with unrealized losses not recognized in income at year-end 2006 and 2005, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position are as follows:
Less Than 12 Months 12 Months or More Total 2006 ----------------------- ------------------------ ------------------------ - ---- Description of Unrealized Unrealized Unrealized Securities Fair Value Loss Fair Value Loss Fair Value Loss - -------------- ---------- ---------- ----------- ---------- ----------- ---------- US Government and federal agency $ 973,437 $15,548 $ 2,929,242 $ 93,194 $ 3,902,679 $108,742 Municipals 1,317,074 3,559 3,064,684 40,051 4,381,758 43,610 Mortgage-backed 995,451 14,296 6,178,661 167,798 7,174,112 182,094 ---------- ------- ----------- -------- ----------- -------- Total temporarily impaired $3,285,962 $33,403 $12,172,587 $301,043 $15,458,549 $334,446 ========== ======= =========== ======== =========== ======== 2005 - ---- US Government and federal agency $ -- $ -- $5,360,898 $166,450 $ 5,360,898 $166,450 Municipals 4,695,870 98,987 361,328 7,440 5,057,198 106,427 Mortgage-backed 3,639,573 49,448 3,956,029 108,168 7,595,602 157,616 ---------- -------- ---------- -------- ----------- -------- Total temporarily impaired $8,335,443 $148,435 $9,678,255 $282,058 $18,013,698 $430,493 ========== ======== ========== ======== =========== ========
The Company evaluates securities for other-than-temporary impairment on a monthly basis. No unrealized losses have been recognized into income as a result. In performing the evaluation, consideration is given to the length of time and the extent to which the fair value has been less than cost, the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value and whether the securities are issued by the federal government or its agencies. At December 31, 2006, thirty-seven debt securities had unrealized losses with aggregate depreciation of 2.16% from the Company's amortized cost basis. Twenty-six of the thirty-seven securities are issued by government agencies. As management has the ability to hold these debt 32 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 - SECURITIES (Continued) securities until maturity, or for the foreseeable future if classified as available for sale, no declines are deemed to be other than temporary. At year-end 2006 and 2005, there were no holdings of securities of any one issuer, other than US Government and its agencies, in an amount greater than 10% of shareholders' equity. Securities pledged at year-end 2006 had a carrying amount of $6,820,794 and were pledged to secure repurchase agreements and Federal Home Loan Bank advances. Pledged securities at year-end 2005 had a carrying amount of $10,376,141. NOTE 3 - LOANS Loans at year-end were as follows:
2006 2005 ------------ ------------ Commercial $ 90,422,689 $ 85,883,914 Real Estate: Commercial 78,012,565 68,445,169 Residential 10,172,321 9,366,098 Construction 1,334,276 1,636,526 Consumer 27,616,155 27,445,727 ------------ ------------ 207,558,006 192,777,434 Less: Allowance for loan losses (2,549,016) (2,612,581) Net deferred loan fees (125,630) (132,692) ------------ ------------ Loans, net $204,883,360 $190,032,161 ============ ============
Activity in the allowance for loan losses for the year was as follows:
2006 2005 ---------- ---------- Beginning balance $2,612,581 $2,039,198 Charge-offs (841,693) (311,056) Recoveries 57,427 30,711 Provision for loan losses 720,701 853,728 ---------- ---------- Ending balance $2,549,016 $2,612,581 ========== ==========
Impaired loans were as follows:
2006 2005 ---------- ---------- Year-end loans with no allocated allowance for loan losses $ 244,329 $ -- Year-end loans with allocated allowance for loan losses 1,209,023 1,773,036 ---------- ---------- Total $1,453,352 $1,773,036 ========== ========== Amount of the allowance for loan losses allocated $ 230,856 $ 564,454
33 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 3 - LOANS (CONTINUED)
2006 2005 ---------- -------- Average of impaired loans during the year $1,090,796 $625,295 Interest income recognized during impairment 15,602 8,845 Cash-basis interest income recognized 10,366 7,341
Non-performing loans were as follows:
2006 2005 ---------- -------- Loans past due over 90 days still on accrual $729,965 $378,658 Non-accrual loans 400,597 748,990
Non-performing loans and impaired loans are defined differently. Some loans may be included in both categories, whereas other loans may only be included in one category. NOTE 4 - PREMISES AND EQUIPMENT Year-end premises and equipment were as follows:
2006 2005 ----------- ---------- Land & land improvements $ 4,913,807 $3,744,028 Buildings & building improvements 4,069,215 1,689,664 Furniture, fixtures and equipment 2,922,359 2,245,604 Construction in Process 1,082,722 273,738 ----------- ---------- 12,988,103 7,953,034 Less: accumulated depreciation 2,029,282 2,030,148 ----------- ---------- $10,958,821 $5,922,886 =========== ==========
Depreciation expense was $315,340 and $301,812 for 2006 and 2005 respectively. The Bank built a fourth location in 2006 in Norton Shores and began construction on two other buildings intended for the North Muskegon and Grand Haven branches which are currently operated out of leased space. Additionally, the Bank purchased property located on Apple Avenue at Quarterline for a possible fifth banking facility. NOTE 5 - DEPOSITS Deposits at year-end are summarized as follows:
2006 2005 ------------ ------------ Non-interest-bearing DDA $ 17,179,082 $ 16,564,735 Interest-bearing DDA 18,606,890 23,465,273 Money market 17,648,173 17,408,588 Savings 13,113,050 14,432,484 Certificate of deposit 147,735,217 118,580,021 ------------ ------------ $214,282,412 $190,451,101 ============ ============
Time deposits of $100,000 or more were $108,580,971 and $89,657,191 at year-end 2006 and 2005, respectively. 34 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 - DEPOSITS (CONTINUED) Scheduled maturities of time deposits, as of year-end 2006, were as follows: 2007 $106,255,405 2008 33,288,080 2009 713,041 2010 1,616,611 2011 5,862,080 ------------ $147,735,217 ============
Brokered time deposits were $78,468,820 at year-end 2006 and $66,082,872 at year-end 2005, respectively. NOTE 6 - SHORT-TERM BORROWINGS Short-term borrowings are generally comprised of federal funds purchased and repurchase agreements. Federal funds purchased are overnight borrowings from various correspondent banks. Repurchase agreements are advances by customers that are not covered by federal deposit insurance. This obligation of the Bank is secured by bank-owned securities held by a third-party safekeeping agent. The balances at year-end are shown below:
Repurchase Federal Funds Agreements Purchased ---------- ------------- Outstanding at December 31, 2006 $4,494,614 $ -- Average interest rate at year-end 3.34% --% Average balance during year 4,993,710 2,078,479 Average interest rate during year 3.17 5.46 Maximum month end balance during year 5,758,378 6,700,000 Outstanding at December 31, 2005 $ 6,065,010 $ -- Average interest rate at year-end 2.83% --% 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
35 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES Year-end advances from the FHLB are as follows:
Current 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 ========== ==========
After November 2003, all three advances were eligible to convert to a floating rate index at the option of the FHLB. As of December 31, 2006, the FHLB had not exercised their option in any of the cases. If the FHLB exercises its conversion option, the advances may be repaid without penalty. The Bank had both securities and loans pledged as collateral for the above advances at year-end 2006. The fair value of the securities pledged was $1,754,336 and the total of loans pledged was $8,004,973. At year-end 2005, the fair value of the securities was $2,176,248 and the total of loans pledged was $8,229,026. NOTE 8 - SUBORDINATED DEBENTURES 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 and subordinated debentures carry a floating rate of 2.05% over the 3-month LIBOR and was initially set at 4.55125%. The stated maturity is December 30, 2034. The securities are redeemable at par after five years and are, in effect, guaranteed by the Company. Distributions on the trust preferred securities are payable quarterly on March 30th, June 30th, September 30th and December 30th. 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. The subordinated debentures are carried on the Company's consolidated balance sheet as a liability and the interest expense is recorded on the Company's consolidated statement of income. The current rate of interest is 7.41%. NOTE 9 - NOTES PAYABLE The Company has a $5 million revolving line of credit with LaSalle. The total balance outstanding at December 31, 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 lending 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 prepaid in whole or in part without any prepayment penalty. The proceeds were essentially used for the general operating expenses of the Company. 36 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 10 - BENEFIT PLANS The Company's 401(k) benefit plan allows employee contributions up to the dollar limit set by law which was $15,000 in 2006. The Company shifted to a Safe Harbor 401(k) Plan in 2006. The matching formula during the 2006 plan year was 100% of the first 3% of compensation contributed and 50% of the next 3%. In 2005, the matching formula was equal to 75% of the first 6% of the compensation contributed. Essentially the maximum matching contribution for both plan years was unchanged at 4.5% of compensation contributed. The match expense for 2006 and 2005 was $110,040 and $131,066, respectively. NOTE 11 - LEASES The Bank has one operating lease agreement for its Grand Haven location. The lease expires in August 2007. The Bank is currently building a branch in the Grand Haven area and intends to relocate its existing offices in the third quarter of 2007. The future minimum lease payments are as follows at December 31, 2006: 2007 $43,681
For years ended December 31, 2006 and 2005, rental expense was $83,334 and $88,770, respectively. NOTE 12 - INCOME TAXES The consolidated provision for federal income taxes is as follows:
2006 2005 -------- --------- Current payable $460,724 $ 733,946 Deferred liability (benefit) 108,033 (161,519) -------- --------- $568,757 $ 572,427 ======== =========
The net deferred tax asset recorded includes the following amounts of deferred tax assets and liabilities as of December 31, 2006 and 2005:
2006 2005 --------- --------- Deferred tax asset Allowance for loan losses $ 741,102 $ 806,738 Non-accrual loans 30,707 7,324 Organization costs 340 2,380 Deferred loan costs, net 42,715 45,115 Unrealized loss on securities available for sale 94,400 108,811 Other 680 189 --------- --------- 909,944 970,557 Deferred tax liabilities Depreciation (119,254) (73,585) Accretion on securities (2,021) (1,304) Prepaid expenses (34,222) (32,303) Other (13,526) -- --------- --------- (169,023) (107,192) --------- --------- Net deferred tax asset $ 740,921 $ 863,365 ========= =========
37 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 12 - INCOME TAXES (CONTINUED) A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefit related to such assets will not be realized. Management has concluded that a valuation allowance is not needed. A reconciliation of the difference between federal income tax expense and the amount computed by applying the statutory rate of 34% in 2006 and 2005 is as follows:
2006 2005 -------- -------- Tax at statutory rate $640,583 $606,937 Tax exempt interest income (57,970) (38,286) Other (13,856) 3,776 -------- -------- Federal income taxes $568,757 $572,427 ======== ========
NOTE 13 - RELATED PARTY TRANSACTIONS Loans and commitments to principal officers, directors and their affiliates in 2006 were as follows: Beginning balance $ 8,388,156 New loans and line advances 5,672,629 * Effect of changes in related parties (1,595,000) Repayments (6,158,748) ----------- Ending balance $ 6,307,037 ===========
* The effect of a director retiring and no longer being considered a related party. Deposits from principal officers, directors and their affiliates at year-end 2006 and 2005 were $2,462,165 and $3,648,289 respectively. NOTE 14 - STOCK OPTIONS The Company has three share based compensation plans as described below. Total compensation cost that has been charged against income for those plans was $1,328 and $0 for 2006 and 2005, respectively. The total income tax benefit recorded was $0 and $6,752 for 2006 and 2005. Stock Option Plans Options to buy stock were granted to officers under the 1998 Employee Stock Option Plan, which provided for issue of options for up to 150,000 shares of stock of the Company. Exercise price is not less than the market price at date of grant. The maximum option term is ten years, and presently outstanding options vest over three years. Options to buy stock were granted to nonemployee directors of the Company under the Director Stock Option Plans of 2003 and 2005. Both plans provided for the issuance of options for up to 20,000 shares of stock of the Company. The exercise price for options issued under these plans was not less than the market price per share as of the date of grant. The maximum option term is ten years for both grants. Outstanding options under this plan were exercisable in full as of the date the options were granted. 38 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The fair value of options granted was determined using the following weighted-average assumptions as of grant date (no options were granted in 2006): NOTE 14 - STOCK OPTIONS (CONTINUED)
2005 ------ Risk-free interest rate 4.48% Expected option life 8.55 yrs Expected stock price volatility 32.77% Dividend yield --% Computed fair value $ 7.26
A summary of the activity in the plans is as follows:
Weighted Weighted Average Average Remaining Aggregate Exercise Contractual Intrinsic Shares Price Term Value ------- -------- ------------- --------- Outstanding at beginning of year 155,775 $10.55 Granted -- Exercised (40,000) 10.00 Forfeited or expired -- -- ------- ------ ---- -------- Outstanding at end of year 115,775 $10.74 4.4 $303,331 ======= ====== ==== ======== Exercisable at end of year 115,775 $10.74 4.4 $303,331 ======= ====== ==== ========
A summary of changes in the Company's nonvested options for the year follows:
Weighted Shares Average Price ------ ------------- Issued and unvested at January 1, 2006 281 $10.28 Vested (281) 10.28 Forfeited -- -- ---- ------ Issued and unvested at December 31, 2006 -- $ --
Information related to stock option plans during each year follows:
2006 2005 -------- ------- Instrinsic value of options exercised $103,600 $20,936 Cash received from option exercises 400,000 69,604 Tax benefit realized from option exercises 0 6,752 Weighted average fair value of options granted 0 7.26
As of December 31, 2006, there were no unvested options and therefore no unrecognized compensation cost related to options granted. Additionally, there were only 2,000 shares available for grant. 39 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 15 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS Banks are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At December 31, 2006 and 2005, the Bank was designated as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that date that management believes have changed the Bank's category. Actual and required capital amounts and ratios for 2006 and 2005 are presented below:
Minimum Required to be Well Capitalized Minimum Required Under Prompt for Capital Corrective Action Actual Adequacy Purposes Provisions ------------------- ------------------- ------------------- Amount Ratio Amount Ratio Amount Ratio ----------- ----- ----------- ----- ----------- ----- 2006 - ---- Total Capital to risk-weighted assets of the Bank $23,532,791 10.45% $18,020,232 8.00% $22,525,290 10.00% Tier one (Core) Capital to risk- risk-weighted assets of the Bank 20,983,775 9.32 9,010,116 4.00 13,515,174 6.00 Tier one (Core) Capital to Average assets of the Bank 20,983,775 8.73 9,618,321 4.00 12,022,901 5.00 2005 - ---- Total Capital to risk-weighted assets of the Bank $21,683,639 10.70% $16,230,267 8.00% 20,287,834 10.00% Tier one (Core) Capital to risk- risk-weighted assets of the Bank 19,148,629 9.44 8,115,134 4.00 12,172,700 6.00 Tier one (Core) Capital to Average assets of the Bank 19,148,629 8.70 8,801,143 4.00 11,001,429 5.00
In addition to the limitations on tier one capital, Federal Reserve guidelines limit the amount of allowance for loan losses that can be included in tier two capital. In general only 1.25% of net risk-weighted assets is allowed to be included. At December 31, 2006, the entire balance of the allowance for loan losses, $2,549,016, was counted in the calculation. At year-end 2005, only $2,535,278 was counted as tier two and $77,303 was disallowed. 40 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Bank received no contributions of capital from the Company in 2006. In 2005, the Company contributed $500,000 of the proceeds from the trust preferred securities to the Bank's capital account. NOTE 15 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS (CONTINUED) Federal and state banking laws and regulations place certain restrictions on the amount of dividends the Bank can transfer to the Company and on the capital levels that must be maintained. At year-end 2006, under the most restrictive of these regulations (to remain well capitalized), the Bank could distribute approximately $1,000,000 to the Company as dividends without prior regulatory approval. At this time the Company's ability to pay dividends is dependent on the Bank. NOTE 16 - OFF-BALANCE SHEET ACTIVITIES Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection, are issued to meet customer financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment. The contractual amount of financial instruments with off-balance-sheet risk was as follows at year-end:
2006 2005 ------------------------ ------------------------ Fixed Variable Fixed Variable Rate Rate Rate Rate ---------- ----------- ---------- ----------- Unused lines of credit $1,947,562 $34,539,370 $ 613,904 $35,959,399 Unused standby letters of credit -- 2,649,000 1,350,000 -- Commitments to make loans 816,646 -- 271,127 --
Commitments to make loans are generally made for periods of 60 days or less. The fixed rate loan commitments have interest rates ranging from 6.00% to 10.00% and maturities ranging from 1 month to 10 years. 41 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 17 - FAIR VALUES OF FINANCIAL INSTRUMENTS Carrying amount and estimated fair values of financial instruments were as follows at year-end:
2006 2005 ------------------- ------------------- Carrying Fair Carrying Fair Amount Value Amount Value -------- -------- -------- -------- (In Thousands) Financial assets Cash and cash equivalents $ 9,070 $ 9,070 $ 4,651 $ 4,651 Securities available for sale 13,184 13,184 13,984 13,984 Securities held to maturity 5,258 5,220 4,918 4,822 Loans held for sale 165 165 -- -- Loans, net 204,883 204,770 190,032 190,491 FHLB stock 404 404 425 425 Accrued interest receivable 1,250 1,250 994 994 Financial liabilities Deposits 214,282 215,571 190,451 189,822 Federal funds purchased and Repurchase agreements 4,495 4,495 6,065 6,065 FHLB Advances 6,000 6,207 6,000 6,206 Subordinated debentures 4,500 4,500 4,500 4,500 Notes Payable 400 400 -- -- Accrued interest payable 330 330 294 294
The methods and assumptions used to estimate fair value are described as follows: Carrying amount is the estimated fair value for cash and cash equivalents, short-term borrowings, Federal Home Loan Bank stock, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of loans held for sale is based on market quotes. Fair value of debt is based on current rates for similar financing. Estimated fair value for other financial instruments and off-balance-sheet loan commitments are considered to approximate carrying value. 42 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 18 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION Following are condensed parent company only financial statements: CONDENSED BALANCE SHEETS December 31,
2006 2005 ----------- ----------- ASSETS Cash and cash equivalents $ 303,470 $ 124,551 Investment in and advances to Community Shores Bank 20,800,528 18,937,408 Investment in and advances to Community Shores Financial Services 26,045 20,601 Investment in and advances to Community Shores Trust 57 -- Equipment, net 3,542 6,042 Other assets 18,379 17,282 ----------- ----------- Total assets $21,152,021 $19,105,884 =========== =========== LIABILITIES AND EQUITY Accrued expenses and other liabilities $ 133,396 $ 105,973 Notes payable 400,000 -- Subordinated debentures 4,500,000 4,500,000 Shareholders' equity 16,118,625 14,499,911 ----------- ----------- Total liabilities and shareholders' equity $21,152,021 $19,105,884 =========== ===========
CONDENSED STATEMENTS OF INCOME Years ended December 31,
2006 2005 ---------- ---------- Other income $ 6,177 $ 9,524 Interest expense (354,841) (251,870) Other expense (446,965) (597,454) ---------- ---------- LOSS BEFORE INCOME TAX BENEFIT AND UNDISTRIBUTED SUBSIDIARY INCOME (795,629) (839,800) Equity in undistributed subsidiary income 1,840,590 1,766,949 FEDERAL INCOME TAX BENEFIT (270,351) (285,532) ---------- ---------- NET INCOME $1,315,312 $1,212,681 ========== ==========
43 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 18 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (Continued) CONDENSED STATEMENTS OF CASH FLOWS Years ended December 31,
2006 2005 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 1,315,312 $ 1,212,681 Equity in undistributed subsidiary income (1,840,590) (1,766,949) Adjustments: Depreciation and amortization 2,500 -- Stock option compensation expense 1,328 -- Tax benefit from stock option exercises -- 6,752 Net change in: Change in other assets (1,097) 6,389 Change in other liabilities 27,423 (21,292) ----------- ----------- Net cash from operating activities (495,124) (562,419) CASH FLOWS FROM INVESTING ACTIVITIES Additions to equipment, net -- (6,042) Capital investment into Community Shores Bank -- (500,000) Capital investment into Community Shores Trust (57) -- ----------- ----------- Net cash from investing activities (57) (506,042) CASH FLOWS FROM FINANCING ACTIVITIES Draws on notes payable and line of credit 600,000 -- Paydown on notes payable (200,000) -- Proceeds from exercise of stock options 274,100 69,604 ----------- ----------- Net cash from financing activities 674,100 69,604 ----------- ----------- Net change in cash and cash equivalents 178,919 (998,857) Beginning cash and cash equivalents 124,551 1,123,408 ----------- ----------- ENDING CASH AND CASH EQUIVALENTS $ 303,470 $ 124,551 =========== ===========
NOTE 19 - OTHER COMPREHENSIVE INCOME (LOSS) Other comprehensive income (loss) components and related tax effects were as follows:
2006 2005 -------- --------- Unrealized holding gains (losses) on available-for-sale securities $ 42,385 $(285,543) Less reclassification adjustments for (gains) and losses later recognized in income -- -- -------- --------- Net unrealized gain (loss) 42,385 (285,543) Tax effect (14,411) 97,085 -------- --------- Other comprehensive income (loss) $ 27,974 $(188,458) ======== =========
44 COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 20 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Earnings Per Share --------------- (in thousands except per Interest Net Interest Net Fully share data) Income Income Income Basic Diluted -------- ------------ ------ ----- ------- 2006 - ---- First Quarter $3,810 $2,075 $364 $.25 $.25 Second quarter 4,040 2,113 342 .24 .23 Third quarter 4,287 2,164 363 .25 .25 Fourth quarter(1) 4,353 2,126 247 .17 .17 2005 - ---- First quarter $2,995 $1,945 $362 $.25 $.25 Second quarter 3,274 2,002 343 .24 .23 Third quarter 3,556 2,100 389 .27 .26 Fourth quarter(2) 3,713 2,114 119 .08 .08
- ---------- (1) Earnings were impacted by expenses associated with opening a fourth banking location and collection expenses incurred on non-performing loans. (2) Earnings were impacted by provision expense for non-performing loans. 45 SHAREHOLDER INFORMATION SEC FORM 10-KSB COPIES OF THE COMPANY'S ANNUAL REPORT ON FORM 10-KSB, AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION, ARE AVAILABLE TO SHAREHOLDERS WITHOUT CHARGE, UPON WRITTEN REQUEST. PLEASE MAIL YOUR REQUEST TO TRACEY A. WELSH, SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER, AT 1030 W. NORTON AVENUE, MUSKEGON, MICHIGAN 49441. STOCK INFORMATION Community Shores Bank Corporation common stock is traded on the Nasdaq Capital Market under the ticker symbol "CSHB." At March 16, 2007, there were approximately 194 record holders of the Company's common stock. The Company has paid no dividends since its formation in 1998. The following table shows the high and low sales prices for the common stock of the Company by quarter during 2006 and 2005 as reported by the Nasdaq Capital Market. SALES PRICES
HIGH LOW ------ ------ CALENDAR YEAR 2006 First Quarter $15.15 $11.50 Second Quarter 12.76 11.70 Third Quarter 12.94 12.00 Fourth Quarter 14.00 12.40 CALENDAR YEAR 2005 First Quarter $14.00 $12.00 Second Quarter 13.70 11.50 Third Quarter 15.86 14.22 Fourth Quarter 15.70 14.05
MARKET MAKERS At January 25, 2007, the following firms were registered with Nasdaq as market makers in common stock of the Company: Citigroup Global Markets Inc. 390 Greenwich Street, 3rd Floor New York, NY 10013 Hill, Thompson, Magid and Co. 15 Exchange Place, Suite 800 Jersey City, New Jersey 07302 Howe Barnes Investments, Inc. 135 South LaSalle Street Chicago, Illinois 60603 Knight Equity Markets, L.P. 525 Washington Blvd. 30th Floor Jersey City, New Jersey 07310 Monroe Securities, Inc. 47 State Street Rochester, New York 14614 Oppenheimer 300 River Place, Suite 4000 Detroit, MI 48207 Sterne, Agee & Leach, Inc. 800 Shades Creek Pkwy., Suite 700 Birmingham, AL 35209 Stifel, Nicolaus & Co., Inc. 100 Light Street Baltimore, MD 21202 UBS Securities LLC 677 Washington Blvd. Stamford, CT 06901 Wedbush Morgan Securities, Inc. 1000 Wilshire Blvd., Suite 900 Los Angeles, CA 90017 46 STOCK REGISTRAR AND TRANSFER AGENT Mellon Investor Services, LLC 480 Washington Boulevard Jersey City, New Jersey 07310 1-800-288-9541 www.melloninvestor.com LEGAL COUNSEL Dickinson Wright PLLC 500 Woodward Avenue, Suite 4000 Detroit, Michigan 48226 and 200 Ottawa Avenue, N.W., Suite 900 Grand Rapids, Michigan 49503 INDEPENDENT AUDITORS Crowe Chizek and Company LLC 55 Campau Avenue N.W., Suite 300 Grand Rapids, Michigan 49503 ADDITIONAL INFORMATION News media representatives and those seeking additional information about the Company should contact Heather D. Brolick, President and Chief Executive Officer of the Company, at (231) 780-1800, or by writing her at 1030 W. Norton Avenue, Muskegon, Michigan 49441. ANNUAL MEETING This year's Annual Meeting will be held at 2:00 p.m., on Thursday, May 10, 2007, at the Muskegon Country Club, 2801 Lakeshore Drive, Muskegon, Michigan. 47 COMMUNITY SHORES BANK DIRECTORS AND OFFICERS BOARD OF DIRECTORS Gary F. Bogner Real Estate Developer (Chairman, non-officer) Heather D. Brolick President, Chief Executive Officer and Secretary Robert L. Chandonnet Owner and President, The Nugent Sand Company, Inc. Dennis L. Cherette An Owner and President, Investment Property (Vice Chairman, non-officer) Associates, Inc. Bruce J. Essex Chairman, Port City Die Cast Steven P. Moreland President and Chief Executive Officer, Automatic Spring Products Corporation Joy R. Nelson Retired Vice President, Huntington Bank Bruce C. Rice President, ESCO Company (chemical manufacturer) Jonathan L. Smith Director of Strategic Planning, Investment Property Associates, Inc. Roger W. Spoelman President and Chief Executive Officer, Mercy General Health Partners (regional hospital) MANAGEMENT TEAM Heather D. Brolick President, Chief Executive Officer and Secretary Ralph R. Berggren Senior Vice President and Chief Lending Officer Michael E. Jeruzal Senior Vice President of Retail Lending and President Community Shores Mortgage Company Amy L. Schultz Vice President and Technology/Operations Manager Lori E. Versalle Vice President and Branch Administrator Tracey A. Welsh Senior Vice President, Chief Financial Officer and Treasurer
48 OFFICERS OF THE BANK Joel M. Andersen Portfolio Manager Faith A. Biros Deposit Processing Manager Monica J. Bixeman Retail Banking Officer Sherri S. Campbell Vice President / Deposit Operations Manager John M. Clark Vice President / Commercial Lending Officer Laurie L. Cordes Vice President / Mortgage Loan Officer Margaret M. Coutchie Assistant Vice President / Controller Lisa R. DeLass Senior Vice President / Mortgage Loan Officer Jennifer L. Egeler Assistant Controller Thomas A. Ellis Senior Vice President / Mortgage Loan Officer Melissa A. Evans Vice President / Commercial Lending Officer Joseph C. Freismuth Mortgage Loan Officer Sharon L. Gary Human Resources Manager Martin B. Hillila Vice President / Commercial Lending Officer Jon M. Huizenga Mortgage Loan Officer Robert J. Jacobs Senior Vice President / Business Development Officer Susan M. Kane Vice President / Mortgage Loan Operation Manager Alan W. Kowalski Assistant Vice President / Collections Manager Kimberli A. LaVallee Assistant Vice President / Grand Haven Branch Manager Jean A. Lynch Main Office Branch Manager Ronald Maciejewski Vice President / Commercial Lending Officer Melissa S. Medendorp Assistant Vice President / Credit Manager Patricia A. Nardi Assistant Vice President / Loan Operations Manager Renee L. Nyblade Vice President / Mortgage Loan Officer Sharon Prus Assistant Vice President / North Muskegon Branch Manager Eric B. Seifert Senior Vice President / Commercial Lending Officer Clinton A. Todd Vice President / Retail Lending Brenda K. Trebian-Kolenda Assistant Vice President / Harvey Branch Manager and Business Development Officer
49 COMMUNITY SHORES BANK CORPORATION DIRECTORS AND OFFICERS BOARD OF DIRECTORS Gary F. Bogner Real Estate Developer (Chairman, non-officer) Heather D. Brolick President, Chief Executive Officer and Secretary Robert L. Chandonnet Owner and President, The Nugent Sand Company, Inc. Dennis L. Cherette An Owner and President, Investment Property (Vice Chairman, non-officer) Associates, Inc. Bruce J. Essex Chairman, Port City Die Cast Steven P. Moreland President and Chief Executive Officer, Automatic Spring Products Corporation Joy R. Nelson Retired Vice President, Huntington Bank Bruce C. Rice President, ESCO Company (chemical manufacturer) Jonathan L. Smith Director of Strategic Planning, Investment Property Associates, Inc. Roger W. Spoelman President and Chief Executive Officer, Mercy General Health Partners (regional hospital) EXECUTIVE OFFICERS Heather D. Brolick President, Chief Executive Officer and Secretary Ralph R. Berggren Senior Vice President Tracey A. Welsh Senior Vice President, Chief Financial Officer and Treasurer
50 EX-21 4 k13450exv21.txt SUBSIDIARIES OF THE ISSUER EXHIBIT 21 SUBSIDIARIES OF COMMUNITY SHORES BANK CORPORATION Community Shores Bank, a Michigan banking corporation Wholly-owned bank subsidiary of Community Shores Bank Corporation Community Shores Capital Trust I A Delaware business trust subsidiary of Community Shores Bank Corporation Community Shores Financial Services, Inc., a Michigan business corporation Wholly-owned subsidiary of Community Shores Bank Corporation Community Shores Mortgage Company Wholly-owned subsidiary of Community Shores Bank All four of the subsidiaries named above with the exception of Community Shores Capital Trust I were organized under the laws of the State of Michigan. Community Shores Capital Trust I was organized under the laws of the State of Delaware. EX-23 5 k13450exv23.txt CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM EXHIBIT 23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in the Registration Statements of Community Shores Bank Corporation on Form S-8 (Registration Nos.333-89655 and 333-107675) of our report dated March 14, 2007 on the 2006 consolidated financial statements of Community Shores Bank Corporation, which report is included in the 2006 Annual Report on Form 10-KSB of Community Shores Bank Corporation. /s/ Crowe Chizek and Company LLC Grand Rapids, Michigan March 26, 2007 EX-31.1 6 k13450exv31w1.txt RULE 13A-14(A) CERTIFICATION OF THE PRINCIPAL EXECUTIVE OFFICER EXHIBIT 31.1 RULE 13A-14(A) CERTIFICATIONS I, Heather D. Brolick, President, Chief Executive Officer and Secretary of Community Shores Bank Corporation, certify that: 1. I have reviewed this report on Form 10-KSB of Community Shores Bank Corporation; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report; 4. The small business issuer's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter (the small business issuer's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting; and 5. The small business issuer's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal control over financial reporting. Date: April 2, 2007 /s/ Heather D. Brolick ---------------------------------------- Heather D. Brolick President, Chief Executive Officer and Secretary EX-31.2 7 k13450exv31w2.txt RULE 13A-14(A) CERTIFICATION OF THE PRINCIPAL FINANCIAL OFFICER EXHIBIT 31.2 RULE 13A-14(A) CERTIFICATIONS I, Tracey A. Welsh, Senior Vice President, Chief Financial Officer and Treasurer of Community Shores Bank Corporation, certify that: 1. I have reviewed this report on Form 10-KSB of Community Shores Bank Corporation; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report; 4. The small business issuer's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter (the small business issuer's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting; and 5. The small business issuer's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal control over financial reporting. Date: April 2, 2007 /s/ Tracey A. Welsh. ---------------------------------------- Tracey A. Welsh Senior Vice President, Chief Financial Officer and Treasurer EX-32.1 8 k13450exv32w1.txt SECTION 1350 CHIEF EXECUTIVE OFFICER CERTIFICATION EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, and accompanies the annual report on Form 10-KSB for the year ended December 31, 2006 (the "Form 10-KSB") of Community Shores Bank Corporation (the "Issuer"). I, Heather D. Brolick, President, Chief Executive Officer and Secretary of the Issuer, certify that: (i) the Form 10-KSB fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d); and (ii) to my knowledge, the information contained in the Form 10-KSB fairly presents, in all material respects, the financial condition and results of operations of the Issuer as of and for the period covered by the report. Dated: April 2, 2007 /s/ Heather D. Brolick ---------------------------------------- Heather D. Brolick President, Chief Executive Officer and Secretary EX-32.2 9 k13450exv32w2.txt SECTION 1350 CHIEF FINANCIAL OFFICER CERTIFICATION EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, and accompanies the annual report on Form 10-KSB for the year ended December 31, 2006 (the "Form 10-KSB") of Community Shores Bank Corporation (the "Issuer"). I, Tracey A. Welsh, Senior Vice President, Chief Financial Officer and Treasurer of the Issuer, certify that: (i) the Form 10-KSB fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d); and (ii) to my knowledge, the information contained in the Form 10-KSB fairly presents, in all material respects, the financial condition and results of operations of the Issuer as of and for the period covered by the report. Dated: April 2, 2007 /s/ Tracey A. Welsh ---------------------------------------- Tracey A. Welsh Senior Vice President, Chief Financial Officer and Treasurer -----END PRIVACY-ENHANCED MESSAGE-----