10QSB 1 k21531e10qsb.txt FORM 10-QSB U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-QSB [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2007 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________. Commission File No. 000-51166 COMMUNITY SHORES BANK CORPORATION (Exact name of small business issuer as specified in its charter) Michigan 38-3423227 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization)
1030 W. NORTON AVENUE, MUSKEGON, MICHIGAN 49441 (Address of principal executive offices) (231) 780-1800 (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark whether the registrant is a shell company (as defined by Rule 12-b2 of the Exchange Act). Yes No X ----- ----- At October 31, 2007, 1,468,800 shares of Common Stock of the issuer were outstanding. Transitional Small Business Disclosure Format: Yes No X ----- ----- Community Shores Bank Corporation Index
Page No. -------- PART I. Financial Information Item 1. Financial Statements.............................. 1 Item 2. Management's Discussion and Analysis.............. 14 Item 3. Controls and Procedures........................... 26 PART II. Other Information Item 1. Legal Proceedings................................. 26 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.......................................... 26 Item 3. Defaults upon Senior Securities................... 26 Item 4. Submission of Matters to a Vote of Security Holders........................................... 26 Item 5. Other Information................................. 26 Item 6. Exhibits ......................................... 27 Signatures................................................ 28
PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) COMMUNITY SHORES BANK CORPORATION CONSOLIDATED BALANCE SHEETS (UNAUDITED)
September 30, December 31, 2007 2006 ------------- ------------ (unaudited) ASSETS Cash and due from financial institutions $ 3,901,052 $ 3,398,155 Interest-bearing deposits in other financial institutions 66,121 72,115 Federal funds sold 0 5,600,000 ------------ ------------ Total cash and cash equivalents 3,967,173 9,070,270 Securities Available for sale (at fair value) 13,550,547 13,184,437 Held to maturity (fair value of $5,219,322 at September 30, 2007 and $5,219,555 at December 31, 2006) 5,248,034 5,257,835 ------------ ------------ Total securities 18,798,581 18,442,272 Loans held for sale 921,623 165,070 Loans 229,970,365 207,432,376 Less: Allowance for loan losses 3,111,096 2,549,016 ------------ ------------ Net loans 226,859,269 204,883,360 Federal Home Loan Bank stock 404,100 404,100 Premises and equipment, net 12,641,544 10,958,821 Accrued interest receivable 1,369,554 1,249,680 Other assets 2,322,197 1,807,258 ------------ ------------ Total assets $267,284,041 $246,980,831 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Deposits Non-interest bearing $ 18,175,949 $ 17,179,082 Interest bearing 207,040,122 197,103,330 ------------ ------------ Total deposits 225,216,071 214,282,412 Federal funds purchased and repurchase agreements 13,506,499 4,494,614 Federal Home Loan Bank advances 6,000,000 6,000,000 Subordinated debentures 4,500,000 4,500,000 Notes Payable 1,106,043 400,000 Accrued expenses and other liabilities 592,300 1,185,180 ------------ ------------ Total liabilities 250,920,913 230,862,206 Shareholders' equity Preferred Stock, no par value: 1,000,000 shares authorized and none issued 0 0 Common Stock, no par value: 9,000,000 shares authorized; 1,468,800 and 1,466,800 shares issued at September 30,2007 and December 31, 2006 13,296,462 13,274,098 Retained Earnings 3,171,175 3,027,774 Accumulated other comprehensive loss (104,509) (183,247) ------------ ------------ Total shareholders' equity 16,363,128 16,118,625 ------------ ------------ Total liabilities and shareholders' equity $267,284,041 $246,980,831 ============ ============
See accompanying notes to consolidated financial statements. -1- COMMUNITY SHORES BANK CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS Ended Ended Ended Ended September 30, September 30, September 30, September 30, 2007 2006 2007 2006 ------------- ------------- ------------- ------------- INTEREST AND DIVIDEND INCOME Loans, including fees $4,518,411 $4,098,809 $12,844,252 $11,468,639 Securities 213,087 181,241 632,891 541,281 Federal funds sold, FHLB dividends and other income 2,898 7,095 121,238 126,834 ---------- ---------- ----------- ----------- Total interest income 4,734,396 4,287,145 13,598,381 12,136,754 INTEREST EXPENSE Deposits 2,306,697 1,833,631 6,628,072 5,050,865 Repurchase agreements and federal funds purchased 139,248 107,957 279,755 218,640 Federal Home Loan Bank advances and notes payable 189,736 181,588 546,643 515,328 ---------- ---------- ----------- ----------- Total interest expense 2,635,681 2,123,176 7,454,470 5,784,833 NET INTEREST INCOME 2,098,715 2,163,969 6,143,911 6,351,921 Provision for loan losses 406,675 216,873 802,006 518,625 ---------- ---------- ----------- ----------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,692,040 1,947,096 5,341,905 5,833,296 Noninterest income Service charges on deposit accounts 253,075 239,155 700,132 733,444 Mortgage loan referral fees 9,995 0 9,995 1,437 Gain on sale of loans 34,427 124,610 239,007 141,013 Gain on sale of securities 0 0 1,986 0 Gain (loss) on disposal of equipment 378 0 458 (124) Other 119,547 97,015 345,120 261,250 ---------- ---------- ----------- ----------- Total noninterest income 417,422 460,780 1,296,698 1,137,020 Noninterest expense Salaries and employee benefits 1,288,097 992,048 3,709,793 2,930,124 Occupancy 146,642 100,828 430,217 275,902 Furniture and equipment 170,928 113,069 480,927 311,323 Advertising 38,037 90,778 128,865 174,570 Data processing 109,820 93,185 327,216 289,463 Professional services 131,020 166,603 403,602 424,394 Other 399,612 329,173 1,059,198 1,026,462 ---------- ---------- ----------- ----------- Total noninterest expense 2,284,156 1,885,684 6,539,818 5,432,238 INCOME (LOSS) BEFORE INCOME TAXES (174,694) 522,192 98,785 1,538,078 Federal income tax expense (benefit) (71,690) 159,045 (44,616) 469,347 ---------- ---------- ----------- ----------- NET INCOME (LOSS) $ (103,004) $ 363,147 $ 143,401 $ 1,068,731 ========== ========== =========== =========== Comprehensive income $ 72,812 $ 496,307 $ 222,139 $ 1,092,518 ========== ========== =========== =========== Weighted average shares outstanding 1,468,800 1,449,191 1,468,771 1,440,976 ========== ========== =========== =========== Diluted average shares outstanding 1,468,800 1,476,893 1,485,129 1,471,044 ========== ========== =========== =========== Basic EPS $ (0.07) $ 0.25 $ 0.10 $ 0.74 ========== ========== =========== =========== Diluted EPS $ (0.07) $ 0.25 $ 0.10 $ 0.73 ========== ========== =========== ===========
See accompanying notes to consolidated financial statements. -2- COMMUNITY SHORES BANK CORPORATION STATEMENT OF CHANGES OF SHAREHOLDERS' EQUITY (UNAUDITED)
Accumulated Other Total Common Retained Comprehensive Shareholders' Shares Stock Earnings Income (Loss) Equity --------- ----------- ---------- ------------- ------------- BALANCE AT JANUARY 1, 2006 1,436,800 $12,998,670 $1,712,462 $(211,221) $14,499,911 Proceeds from the exercise of stock options 40,000 400,000 400,000 Stock tendered for option exercises (10,000) (125,900) (125,900) Stock option compensation expense 1,328 1,328 Comprehensive income: Net income 1,068,731 1,068,731 Unrealized gain on securities available-for-sale, net 23,787 23,787 ----------- Total comprehensive income 1,092,518 --------- ----------- ---------- --------- ----------- BALANCE AT SEPTEMBER 30, 2006 1,466,800 $13,274,098 $2,781,193 $(187,434) $15,867,857 ========= =========== ========== ========= =========== BALANCE AT JANUARY 1, 2007 1,466,800 $13,274,098 $3,027,774 $(183,247) $16,118,625 Proceeds from the exercise of stock options 2,000 20,460 20,460 Tax benefit from option exercise 1,904 1,904 Comprehensive income: Net income 143,401 143,401 Unrealized gain on securities available-for-sale 78,738 78,738 Total comprehensive income 222,139 --------- ----------- ---------- --------- ----------- BALANCE AT SEPTEMBER 30, 2007 1,468,800 $13,296,462 $3,171,175 $(104,509) $16,363,128 ========= =========== ========== ========= ===========
See accompanying notes to consolidated financial statements. -3- COMMUNITY SHORES BANK CORPORATION CONSOLIDATED STATEMENTS OF CASHFLOW (UNAUDITED)
Nine Months Nine Months Ended Ended September 30, September 30, 2007 2006 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 143,401 $ 1,068,731 Adjustments to reconcile net income to net cash from operating activities Provision for loan losses 802,006 518,625 Depreciation and amortization 457,703 217,331 Net amortization of securities 3,935 21,357 Net realized gain on sale of securities (1,986) 0 Net realized gain on sale of loans (239,007) (141,013) Net realized (gain) loss on disposal of equipment (458) 124 Loans originated for sale (16,439,600) (2,766,245) Proceeds from loan sales 15,922,054 2,907,257 Stock option compensation expense 0 1,328 Net change in: Accrued interest receivable and other assets (254,375) (1,824,265) Accrued interest payable and other liabilities (592,880) 476,424 ------------ ------------ Net cash from (used in) operating activities (199,207) 479,654 CASH FLOWS FROM INVESTING ACTIVITIES Activity in available-for-sale securities: Sales 494,650 0 Maturities, prepayments and calls 2,670,596 2,159,546 Purchases (3,404,204) (1,247,388) Activity in held-to-maturity securities: Maturities 0 185,000 Purchases 0 (537,262) Loan originations and payments, net (23,198,915) (13,092,412) Redemption of Federal Home Loan Bank stock 0 13,500 Additions to premises and equipment (2,139,968) (2,725,768) ------------ ------------ Net cash used in investing activities (25,577,841) (15,132,784) CASH FLOW FROM FINANCING ACTIVITIES Net change in deposits 10,933,659 15,004,891 Net change in federal funds purchased and repurchase agreements 9,011,885 (1,038,358) Other borrowing activity: Draws on note payable and line of credit 1,512,086 600,000 Paydown on note payable (806,043) (200,000) Tax benefit from exercise of stock options 1,904 0 Net proceeds from exercise of stock options 20,460 274,100 ------------ ------------ Net cash from financing activities 20,673,951 14,640,633 Net change in cash and cash equivalents (5,103,097) (12,497) Beginning cash and cash equivalents 9,070,270 4,651,459 ------------ ------------ ENDING CASH AND CASH EQUIVALENTS $ 3,967,173 $ 4,638,962 ============ ============ Supplemental cash flow information: Cash paid during the period for interest $ 7,286,924 $ 5,599,930 Cash paid during the period for federal income tax 250,000 340,000 Transfers from loans to foreclosed assets 421,000 112,000
See accompanying notes to consolidated financial statements. -4- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION AND RECENT ACCOUNTING DEVELOPMENTS: The unaudited, consolidated financial statements as of and for the three months and nine months ended September 30, 2007 include the consolidated results of operations of Community Shores Bank Corporation ("Company") and its wholly-owned subsidiaries, Community Shores Bank ("Bank") and Community Shores Financial Services, and a wholly-owned subsidiary of the Bank, Community Shores Mortgage Company ("Mortgage Company"). These consolidated financial statements have been prepared in accordance with the instructions for Form 10-QSB and Item 310(b) of Regulation S-B and do not include all disclosures required by generally accepted accounting principles for a complete presentation of the Company's financial condition and results of operations. In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair representation of the results of operations for such periods. The results for the period ended September 30, 2007 should not be considered as indicative of results for a full year. For further information, refer to the consolidated financial statements and footnotes included in the Company's annual report on Form 10-KSB for the period ended December 31, 2006. Some items in the prior year financial statements were reclassified to conform to the current presentation. The Financial Accounting Standards Board ("FASB") Interpretation 48, Accounting for Uncertainty in Income Taxes ("FIN 48"), was adopted as of January 1, 2007. A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. The adoption had no affect on the Company's consolidated financial statements. The Company is only subject to examinations of federal taxing authorities for years after 2004. The Company and its subsidiaries are subject to U.S. federal income tax. The Company is no longer subject to examination by taxing authorities for years before 2004. The Company does not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months. The Company recognizes interest and/or penalties related to income tax matters in income tax expense. The Company did not have any amounts accrued for interest and penalties at September 30, 2007. In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets" ("SFAS 156"). SFAS 156 addresses the accounting for recognized servicing assets and servicing liabilities related to certain transfers of the servicer's financial assets and for acquisitions or assumptions of obligations to service financial assets that do not relate to the financial assets of the servicer and its related parties. SFAS 156 requires that all recognized servicing assets and servicing liabilities are initially measured at fair value, and subsequently measured at either fair value or by applying an amortization method for each class of recognized servicing assets and servicing liabilities. SFAS 156 was adopted as of January 1, 2007 and the Company has chosen -5- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION AND RECENT ACCOUNTING DEVELOPMENTS (Continued): the fair value method of measurement. The adoption of SFAS 156 had no material effect on the Company's consolidated financial statements. In September 2006, the FASB issued Statement No. 157, Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement established a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The Standard is effective for fiscal years beginning after November 15, 2007. The Company has not yet completed its evaluation of the impact of the adoption of this standard. In February 2006, FASB issued Statement No. 159, "The Fair Value Option for Financial Assets and Liabilities" ("SFAS 159"). Adoption of SFAS 159 is required for January 1, 2008. Early adoption was allowed, effective to January 1, 2007, if that election was made by April 30, 2007. This statement allows, but does not require, companies to record certain assets and liabilities at their fair value. The fair value determination is made at the instrument level, so similar assets or liabilities could be partially accounted for using the historical cost method, while other similar assets or liabilities are accounted for using the fair value method. Changes in fair value are recorded through the income statement in subsequent periods. The statement provides for a one time opportunity to transfer existing assets and liabilities to fair value at the point of adoption with a cumulative effect adjustment recorded against equity. After adoption, the election to report assets or liabilities at fair value must be made at the point of their inception. The Company did not elect early adoption of SFAS 159 and has not yet determined which, if any, assets or liabilities may be reported using the fair value accounting method. As such, the Company has not yet determined the impact that the adoption of this statement may have on the Company's consolidated financial statements. 2. SECURITIES The following tables represent the securities held in the Company's portfolio at September 30, 2007 and at December 31, 2006:
Gross Gross Amortized Unrealized Unrealized Fair September 30, 2007 Cost Gains Losses Value ------------------ ---------- ---------- --------- ----------- Available for sale: US Government and federal agency $35,054 $ (46,131) $ 4,467,087 Municipal securities 3,873 0 343,770 Mortgage-backed securities 7,420 (158,563) 8,739,690 ------- --------- ----------- $46,347 $(204,694) $13,550,547 Held to maturity: Municipal securities $5,248,034 $ 5,292 $ (34,004) $ 5,219,322
-6- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 2. SECURITIES (Continued)
Gross Gross Amortized Unrealized Unrealized Fair December 31, 2006 Cost Gains Losses Value ----------------- ---------- ---------- ---------- ----------- Available for sale: US Government and federal agency $ 6,015 $(108,742) $ 4,408,178 Municipal securities 4,500 (2,778) 707,516 Mortgage-backed securities 5,452 (182,094) 8,068,743 ------- --------- ----------- 15,967 (293,614) 13,184,437 Held to maturity: Municipal securities $5,257,835 $ 2,552 $ (40,832) $ 5,219,555
Below is the schedule of maturities for securities held at September 30, 2007:
Held to Maturity Available for Sale ----------------------- Fair Amortized Fair Value Cost Value ------------------ ---------- ---------- Due in one year or less $ 0 $ 0 $ 0 Due from one to five years 3,216,808 1,164,562 1,163,753 Due in more than five years 1,594,049 4,083,472 4,055,569 Mortgage-backed 8,739,690 0 0 ----------- ---------- ---------- $13,550,547 $5,248,034 $5,219,322 =========== ========== ==========
3. LOANS The components of the outstanding loan balances:
September 30, 2007 December 31, 2006 ------------------ ----------------- Commercial $ 88,962,792 $ 90,422,689 Real Estate: Commercial 92,307,219 78,012,565 Residential 14,353,427 10,172,321 Construction 4,791,376 1,334,276 Consumer 29,693,288 27,616,155 ------------ ------------ Subtotal: 230,108,102 207,558,006 Allowance for loan losses (3,111,096) (2,549,016) Net deferred loan fees (137,737) (125,630) ------------ ------------ Loans, Net $226,859,269 $204,883,360 ============ ============
Loans held for sale totaled $921,623 at September 30, 2007 and $165,070 at December 31, 2006. -7- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 4. ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS The following is a summary of activity in the allowance for loan losses account for the three and nine month periods ended September 30, 2007 and 2006:
Three Months Three Months Nine Months Nine Months Ended Ended Ended Ended 9/30/07 09/30/06 9/30/07 09/30/06 ------------ ------------ ----------- ----------- Beginning Balance 2,796,103 $2,436,765 2,549,016 $2,612,581 Charge-offs Commercial (48,856) (80,130) (75,506) (460,737) Real Estate-Commercial 0 0 (25,463) 0 Real Estate-Residential 0 0 0 0 Real Estate-Construction 0 0 0 0 Consumer (52,068) (31,834) (169,637) (176,214) ---------- ---------- ---------- ---------- Total Charge-offs (100,924) (111,964) (270,606) (636,951) ---------- ---------- ---------- ---------- Recoveries Commercial 2,301 1,607 6,925 9,527 Real Estate-Commercial 0 0 0 0 Real Estate-Residential 0 0 0 0 Real Estate-Construction 0 0 0 0 Consumer 6,941 3,546 23,755 43,045 ---------- ---------- ---------- ---------- Total Recoveries 9,242 5,153 30,680 52,572 ---------- ---------- ---------- ---------- Net Charge-Offs (91,682) (106,811) (239,926) (584,379) ---------- ---------- ---------- ---------- Provision for loan losses 406,675 216,873 802,006 518,625 ---------- ---------- ---------- ---------- Ending Balance $3,111,096 $2,546,827 $3,111,096 $2,546,827 ========== ========== ========== ==========
Impaired loans were as follows:
09/30/07 12/31/06 ---------- ---------- Period-end loans with no specific allocated allowance for loan losses: -- $ 244,329 Period-end loans with specific allowance for loan losses: $3,068,558 1,209,023 ---------- ---------- Total: $3,068,558 $1,453,352 ========== ========== Amount of the allowance for loan losses specifically allocated: $ 468,749 $ 230,856
Three Months Three Months Nine Months Nine Months Ended Ended Ended Ended 9/30/07 9/30/06 09/30/07 9/30/06 ------------ ------------ ----------- ----------- Average of impaired loans during the period: $2,513,882 $851,818 $2,244,128 $1,231,918 Interest income recognized during impairment: 3,782 773 36,317 15,224 Cash-basis interest income recognized: 3,305 207 8,649 10,355
-8- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 4. ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued): Non-performing loans were as follows:
09/30/07 12/31/06 ---------- -------- Loans past due over 90 days still on accrual: $ 632,005 $729,965 Non-accrual loans: $2,466,527 $400,597
Non-performing loans and impaired loans are defined differently. Some loans may be included in both categories, whereas other loans may only be included in one category. 5. PREMISES AND EQUIPMENT Period end premises and equipment were as follows:
September 30, December 31, 2007 2006 ------------- ------------ Land & land improvements $ 5,455,864 $ 4,913,807 Buildings & building improvements 5,845,580 4,069,215 Furniture, fixtures and equipment 3,641,227 2,922,359 Construction in Process 20,263 1,082,722 ----------- ----------- 14,962,934 12,988,103 Less: accumulated depreciation 2,321,390 2,029,282 ----------- ----------- $12,641,544 $10,958,821 =========== ===========
6. DEPOSITS The components of the outstanding deposit balances at September 30, 2007 and December 31, 2006 were as follows:
September 30, December 31, 2007 Balance 2006 Balance ------------- ------------ Non-interest bearing Demand $ 18,175,949 $ 17,179,082 Interest bearing Checking 18,740,941 18,606,890 Money Market 21,587,489 17,648,173 Savings 15,426,070 13,113,050 Time, under $100,000 44,666,647 39,154,246 Time, over $100,000 106,618,975 108,580,971 ------------ ------------ Total Deposits $225,216,071 $214,282,412 ============ ============
-9- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 7. SHORT-TERM BORROWINGS The Company's short-term borrowings typically consist of repurchase agreements and federal funds purchased. The September 30, 2007 and December 31, 2006 information was as follows:
Repurchase Federal Funds Agreements Purchased ---------- ------------- Outstanding at September 30, 2007 $5,406,499 $8,100,000 Average interest rate at period end 3.11% 4.95% Average balance during year 5,083,225 3,718,637 Average interest rate during year 3.35% 5.42% Maximum month end balance during year 5,695,329 8,500,000 Outstanding at December 31, 2006 $4,494,614 $ 0 Average interest rate at year end 3.34% 0.00% Average balance during year 4,993,710 2,078,479 Average interest rate during year 3.17% 5.46% Maximum month end balance during year 5,758,378 6,700,000
8. FEDERAL HOME LOAN BANK BORROWINGS The Bank was approved in the first quarter of 1999 to be a member of the Federal Home Loan Bank of Indianapolis. Based on its current Federal Home Loan Bank Stock holdings, the Bank has the capacity to borrow $6,900,000. Each borrowing requires a direct pledge of securities or loans. At September 30, 2007, the Bank had assets with a market value of $9,258,973 pledged to the Federal Home Loan Bank to support current borrowings. Details of the Bank's outstanding borrowings at both September 30, 2007 and December 31, 2006 are:
Current September 30, December 31, Maturity Date Interest Rate 2007 2006 ------------- ------------- ------------- ------------ March 24, 2010 5.99 1,500,000 1,500,000 November 3, 2010 5.95 2,000,000 2,000,000 December 13, 2010 5.10 2,500,000 2,500,000 ---------- ---------- $6,000,000 $6,000,000
9. SUBORDINATED DEBENTURES The subordinated debentures stemmed from a trust preferred security offering. Community Shores Capital Trust I ("the Trust"), a business trust formed by the Company, sold 4,500 Cumulative Preferred Securities ("trust preferred securities") at $1,000 per security in a December 2004 offering. The proceeds from the sale of the trust preferred securities were used by the Trust to purchase an equivalent amount of subordinated debentures from the Company. The trust preferred securities carry a floating rate of 2.05% over the 3-month LIBOR. This was initially set at 4.55125% and is 7.28063% at September 30, 2007. The stated maturity is December 30, 2034. The securities are redeemable at par on any interest payment date on or after December 30, 2009 with -10- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 9. SUBORDINATED DEBENTURES (Continued) regulatory approval, if then required, and are, in effect, guaranteed by the Company. Distributions on the trust preferred securities are payable quarterly on March 30th, June 30th, September 30th and December 30th. The most recent distribution was paid on October 1, 2007 because September 30, 2007 fell on a weekend. Under certain circumstances, distributions may be deferred up to 20 calendar quarters. However, during any such deferrals, interest accrues on any unpaid distributions at a floating rate of 2.05% over the 3-month LIBOR. 10. NOTES PAYABLE On September 7, 2007, the Company refinanced its $5 million line of credit with Fifth Third Bank ("Fifth Third"); the line was formerly with LaSalle Bank National Association ("LaSalle"). The LaSalle line of credit matured during the quarter and had an outstanding balance of $806,043. On December 31, 2006 the balance on the LaSalle line was $400,000. On September 7, 2007, the Company executed its first draw on its line of credit with Fifth Third in the amount of $806,043. The draw was used solely for the purpose of paying off the principal and interest owed to LaSalle upon maturity of the Company's former line of credit. Through September 30, there has been one additional draw for $300,000 which occurred on September 28. The proceeds were essentially used for the general operating expenses of the Company and to contribute capital to the Bank. On September 30, 2007 the outstanding balance and rate on the Fifth Third line was $1,106,043 and 6.75% respectively. The Fifth Third line is floating and bears interest on outstanding principal at a rate of 100 basis points below Fifth Third's internal prime rate, which is currently 7.50%. Interest is owed quarterly in arrears on the first business day of February, May, August, and November and the borrowings may be prepaid in whole or in part without any prepayment penalty. 11. COMMITMENTS AND OFF-BALANCE SHEET RISK Some financial instruments are used to meet financing needs and to reduce exposure to interest rate changes. These financial instruments include commitments to extend credit and standby letters of credit. These involve, to varying degrees, credit and interest-rate risk in excess of the amount reported in the financial statements. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment, and generally have fixed expiration dates. Standby letters of credit are conditional commitments to guarantee a customer's performance to another party. Exposure to credit loss if the customer does not perform is represented by the contractual amount for commitments to extend credit and standby letters of credit. Collateral or other security is normally obtained for these financial instruments prior to their use, and many of the commitments are expected to expire without being used. -11- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 11. COMMITMENTS AND OFF-BALANCE SHEET RISK (Continued) A summary of the notional and contractual amounts of outstanding financing instruments with off-balance-sheet risk as of September 30, 2007 and December 31, 2006 follows:
September 30, December 31, 2007 2006 ------------- ------------ Unused lines of credit and letters of credit $40,650,165 $39,135,932 Commitments to make loans 817,980 816,646
Commitments to make loans generally terminate one year or less from the date of commitment and may require a fee. Since many of the above commitments on lines of credit and letters of credits expire without being used, the above amounts related to those categories do not necessarily represent future cash commitments. 12. INCOME TAXES Federal tax expense was lower in the first nine months of 2007 compared to the first nine months of 2006. The decrease is not only related to lower pre-tax income but also to an adjustment that occurred in the first quarter of 2007 when the Company reevaluated its federal tax accruals and concluded that tax liabilities needed to be modified reducing federal tax expense recorded in that quarter by $36,000. The federal tax benefit that was recorded in both the second and third quarters of 2007 was due to the proportion of tax free municipal bond income to consolidated pre-tax income. 13. REGULATORY MATTERS Banks are subject to regulatory capital requirements administered by the federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet various capital requirements can initiate regulatory action. Prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required. The Bank was designated as well-capitalized under the regulatory framework for prompt corrective action at both September 30, 2007 and December 31, 2006. -12- COMMUNITY SHORES BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 13. REGULATORY MATTERS (Continued) Actual and required capital amounts and ratios at September 30, 2007 and December 31, 2006 for the Bank were:
Minimum Required to Be Well Capitalized Minimum Required Under Prompt For Capital Corrective Action Actual Adequacy Purposes Provisions ------------------- ------------------- ------------------- Amount Ratio Amount Ratio Amount Ratio ----------- ----- ----------- ----- ----------- ----- September 30, 2007 Total Capital (Tier 1 and Tier 2) to risk weighted assets of the Bank $25,163,180 10.07% $19,985,448 8.00% $24,981,810 10.00% Tier 1 (Core) Capital to risk to risk-weighted assets of the Bank 22,052,084 8.83 9,992,724 4.00 14,989,086 6.00 Tier 1 (Core) Capital to to average assets of the Bank 22,052,084 8.35 10,562,320 4.00 13,202,900 5.00 December 31, 2006 Total Capital (Tier 1 and Tier 2) to risk weighted assets of the Bank $23,532,791 10.45% $18,020,232 8.00% $22,525,290 10.00% Tier 1 (Core) Capital to risk to risk-weighted assets of the Bank 20,983,775 9.32 9,010,116 4.00 13,515,174 6.00 Tier 1 (Core) Capital to to average assets of the Bank 20,983,775 8.73 9,618,321 4.00 12,022,901 5.00
-13- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS The discussion below details the financial results of the Company and its wholly owned subsidiaries, the Bank and Community Shores Financial Services, and the Bank's subsidiary, the Mortgage Company, through September 30, 2007 and is separated into two parts which are labeled, Financial Condition and Results of Operations. The part labeled Financial Condition compares the financial condition at September 30, 2007 to that at December 31, 2006. The part labeled Results of Operations discusses the three month and nine month periods ended September 30, 2007 as compared to the same periods of 2006. Both parts should be read in conjunction with the interim consolidated financial statements and footnotes included in Item 1 of Part I of this Form 10-QSB. This discussion and analysis and other sections of this Form 10-QSB contain forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about the Company, the Bank, the Mortgage Company and Community Shores Financial Services. Words such as "anticipates", "believes", "estimates", "expects", "forecasts", "intends", "is likely", "plans", "projects", variations of such words and similar expressions are intended to identify such forward-looking statements. These forward-looking statements are intended to be covered by the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("Future Factors") that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. The Company undertakes no obligation to update, amend, or clarify forward looking statements, whether as a result of new information, future events (whether anticipated or unanticipated), or otherwise. Future Factors include, among others, changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulation; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; changes in the national and local economy; and other factors, including risk factors, referred to from time to time in filings made by the Company with the Securities and Exchange Commission. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement. FINANCIAL CONDITION Total assets increased by $20.3 million to $267.3 million at September 30, 2007 from $247.0 million at December 31, 2006. This is a 8.2% increase in assets during the first nine months of 2007. Asset growth was funded by deposit and borrowings growth and consisted primarily of increases in the loan portfolio and premises and equipment. -14- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS Cash and cash equivalents decreased by $5.1 million to $4.0 million at September 30, 2007 from $9.1 million at December 31, 2006. This decrease was the net effect of increased balances held at other financial institutions being offset by a decrease in federal funds sold. Changes in these balances are related to fluctuations in the liquidity of the Bank and its customers on those particular days. Total loans climbed to $230.0 million at September 30, 2007 from $207.4 million at December 31, 2006. The $22.6 million net increase is comprised of $12.8 million growth in the commercial and commercial real estate portfolios, $7.7 million growth in residential mortgage and construction loans and $2.1 million in consumer loans. The Bank still maintains a focus on commercial lending. However one of the Bank's recent initiatives was to increase its mortgage lending presence in the local marketplace. To execute this strategy, the Bank recruited five well-known, experienced mortgage originators. As in the past, it is the Bank's intention to sell in the secondary market a majority of the residential real estate loans originated, however there will be situations that will require the Bank to retain a loan for its own portfolio. The 41% increase in residential real estate loans since year-end 2006 is not necessarily indicative of future growth in this portfolio. A portion of the residential loan increase was related to an event that occurred late in the second quarter. One of the Bank's main purchasers of its residential loans decided to quickly exit the loan business forcing the Bank to retain several loans that were in the pipeline and slated for sale. Even with the current focus on the mortgage initiative, the Bank intends on maintaining its commercial focus which is evidenced by the fact that the commercial and commercial real estate categories of loans still comprise 79% of the Bank's total loan portfolio. Other lending activity during the first nine months of 2007 included the origination of $16.4 million in loans that were sold in the secondary market, 89% were mortgage loans. Mortgage loans are sold servicing released. The correlated gain on the mortgage activity was $103,000. Other origination activity was related to Small Business Association ("SBA") loans. Since January there have been $1.9 million originated and $1.8 million sold. The associated gains from 2007's sales were $136,000.The Bank's SBA lending program was developed in the second half of 2006 and consists mainly of selling the guaranteed portion of floating rate SBA loans that the Bank originates. The Bank retains the unguaranteed portion which is generally 20% to 25% of the outstanding principal. The originations from these business lines totaled $2.9 million for the first nine months of 2006 with 78% being SBA loans. The total gains recorded for both the sales of SBA and mortgage loans in the first nine months of 2006 were $141,000. -15- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS The Company attempts to mitigate interest rate risk in its loan portfolio in many ways. The main approach is to balance the rate sensitivity of the portfolio and manage extension risk(1). The loan maturities and rate sensitivity of the loan portfolio at September 30, 2007 are included below:
Within Three to One to After Three Twelve Five Five Months Months Years Years Total ----------- ----------- ------------ ----------- ------------ Commercial, financial and other $18,944,466 $34,826,653 $ 33,355,828 $ 2,124,643 $ 89,251,590 Real estate: commercial 14,665,054 19,916,621 55,024,587 2,617,710 92,223,972 construction 288,727 3,555,673 399 946,576 4,791,375 mortgages 97,530 322,137 2,005,355 11,870,982 14,296,004 Consumer 1,991,165 4,020,874 19,847,548 3,547,837 29,407,424 ----------- ----------- ------------ ----------- ------------ $35,986,942 $62,641,958 $110,233,717 $21,107,748 $229,970,365 =========== =========== ============ =========== ============ Loans at fixed rates 8,036,194 13,415,686 94,476,229 18,052,760 133,980,869 Loans at variable rates 27,950,748 49,226,272 15,757,488 3,054,988 95,989,496 ----------- ----------- ------------ ----------- ------------ $35,986,942 $62,641,958 $110,233,717 $21,107,748 $229,970,365 =========== =========== ============ =========== ============
At September 30, 2007, 58% of the loan balances carried a fixed rate and 42% a floating rate. As the mortgage loan activity increases there could be a change in the contractual maturity composition of the Bank's loan portfolio. Generally mortgage loans have a contractual maturity of up to thirty years. Although the contractual maturities may be as long as thirty years, it is common practice for mortgage loans to have an average life that is closer to seven to ten years. Management is watching the entire loan portfolio carefully and is endeavoring to avoid exposing the Bank to excessive extension risk. Since June 30, 2007, the Bank's contractual maturities longer than five years have remained at 9% of the entire portfolio. The recent economic climate in Michigan has been very weak particularly in the real estate sector. The most vulnerable credits appear to be loans secured by real estate for the purposes of land development. Although the Bank has a significant level of commercial real estate loans, a large portion of the real estate collateral is owner-occupied. Less than 5% of the Bank's entire loan portfolio is in land development loans. Credit risk is another type of risk inherent in banking. Management is actively involved in credit risk oversight. Monthly the loan portfolio is reviewed and analyzed for the purpose of estimating probable incurred credit losses. The allowance for loan losses is adjusted accordingly to maintain an adequate level based on that analysis given the risk characteristics of the loan portfolio. At September 30, 2007, the allowance totaled $3.1 million. Management has determined that this is an appropriate level based on its detailed review of the loan portfolio using a consistent methodology involving loan ratings, delinquency trends, historical loss experience as well as current economic conditions. ---------- (1) Extension risk, as related to loans, exists when booking fixed rate loans with long final contractual maturities. When a customer is contractually allowed longer to return their borrowed principal and rates rise, the Bank is delayed from taking advantage of the opportunity to reinvest the returning principal at the higher market rate. -16- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS The allocation of the allowance at September 30, 2007 was as follows:
September 30, 2007 December 31, 2006 -------------------------- -------------------------- Percent of Percent of Allowance Allowance Related to Related to Amount Loan Category Amount Loan Category ---------- ------------- ---------- ------------- Balance at End of Period Applicable to: Commercial $1,464,147 47.1% $1,239,909 48.7% Real estate: Commercial 1,224,499 39.4 943,907 37.0 Residential 71,480 2.3 50,862 2.0 Construction 55,101 1.7 15,344 0.6 Consumer 295,869 9.5 298,994 11.7 ---------- ----- ---------- ----- Total $3,111,096 100.0% $2,549,016 100.0% ========== ===== ========== =====
The ratio of allowance for loan losses to total loans increased to 1.35% from a level of 1.23% at December 31, 2006. The increase is related to the $2.1 million increase in non-accrual loans since year-end 2006 as well as the declining real estate market in Michigan. Management continues to monitor the allocations on a monthly basis and makes adjustments to the provision and the allowance based on portfolio concentration levels, actual loss experience and the financial condition of the borrowers. An additional $802,000 was added to the allowance through provision for loan losses during the first nine months of 2007 with $407,000 being added in the third quarter. During the third quarter there was a specific allocation of over $100,000 for a commercial customer that unexpectedly filed bankruptcy. Another significant factor considered in the assessment of the adequacy of the allowance is the quality of the loan portfolio from a past due standpoint. Below is a table, which details the past due balances at September 30, 2007 compared to those at year-end 2006 and the corresponding change, related to those two periods.
Increase Loans Past Due: September 30, 2007 December 31, 2006 (Decrease) --------------- ------------------ ----------------- ---------- 30-59 days $1,042,462 $1,407,140 $ (364,678) 60-89 days 1,232,884 885,689 347,195 90 days and greater 632,005 729,965 (97,960) Non accrual loans $2,466,527 $ 400,597 $2,065,930
Since year-end 2006, overall past due and non accrual balances balances have decreased by $1.9 million. Non accruals have increased by $2.1 million and were slightly offset by a $115,000 decrease in loans past due. A portion of the non accrual activity is related to loans moving out of various past due categories and being reclassed into the non-accrual category. Five commercial relationships comprise almost the entire balance. The primary collateral supporting the borrowings in four of the five cases is real estate and as a result of the declining real estate market in the state of Michigan, there have been increased specific allocations relative to impaired loans particularly those that have real estate based collateral. The current allowance allocations for these impaired loans are considered adequate based on expected loss on -17- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS disposition of collateral. The increase in specific allocations has had a considerable increase on the provision expense recorded in the first nine months of 2007. Although the collection process is believed to be sound, there was still the need to charge-off loans. Annualized net charge-offs to average loans was 0.15% for the first nine months of 2007, down from 0.40% for the first nine months of 2006. There were net charge-offs of $240,000 recorded for the first nine months of 2007, which is much lower than net charge-offs of $584,000 for the similar period in 2006. Approximately 40% of the balances charged off in the first nine months of 2006 had specific allocations in the allowance for loan losses and many were on non accrual status. More than half (56%) of the recorded charge-offs in the first nine months of 2006 were related to one impaired commercial relationship which was identified in the fourth quarter of 2005. Bank premises and equipment increased $1.7 million during the first nine months of 2007. A small portion of the increase was the remaining costs associated with the completion of the North Muskegon branch building which became operational on January 5, 2007. The other significant expenditure was for the construction of a building for the Bank's Grand Haven banking location. The Grand Haven branch relocated from its leased space in August 2007 to its new building near the corner of US-31 and Taylor Street. The Company has completed all of its construction projects as of September 2007. The Bank owns one vacant land parcel at the corner of Apple Avenue and Quarterline in the City of Muskegon. There are no immediate plans to build on the Apple Avenue land. Other assets rose $515,000 since December 31, 2006. The largest item contributing to the change is the addition of $421,000 in other real estate owned between the two period ends. Other real estate owned is comprised of properties relinquished by customers through the collection process. As properties are added to other real estate owned they are written down to market value (less estimated selling costs) based on a professional appraisal or other common means of valuation. Currently there are 6 properties being held. There have been three properties added and one disposition since December 31, 2006. The largest addition during the first nine months of 2007 was a residence in the Grand Haven area. If any property in this category is sold for less than it is being held, further losses could result. Deposit balances were $225.2 million at September 30, 2007 up from $214.3 million at December 31, 2006. Total deposit growth since year-end was $10.9 million or 5.1%. Increases were recorded in all types of accounts except time deposits greater than $100,000. The growth in deposits has allowed the Bank to surpass one of its super regional, local competitors to attain third position in deposit market share in the Bank's defined market area(1). Deposit growth is due to several of the Bank's large public fund customers increasing their holdings since year-end as well as contributions from the enhanced branch system. Since year-end 2006, non-interest bearing checking accounts increased nearly $1 million or 5.8% while interest bearing checking accounts and savings accounts grew $6.4 million. Local time deposits grew $5.5 million in the first nine months of 2007. Resulting from the growth of local ---------- (1) The defined market area referred to in this statistic consists of the northern Ottawa communities of Ferrysburg, Spring Lake and Grand Haven and all Muskegon County communities except Montague. -18- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS deposits the Bank was able to reduce its concentration of brokered deposits. Brokered deposits are time deposits obtained from depositors located outside of the Bank's market area and are placed with the Bank by a deposit broker. Since December 31, 2006, the Bank decreased its total balance of brokered deposits by $2.0 million and the ratio of brokered deposits to total deposits decreased from 37% at December 31, 2006 to a level of 34% at September 30, 2007. The Bank intends on decreasing its dependency on brokered funds as its branching network in the local market strengthens. The notes payable balance consists of draws on the Company's $5 million revolving line of credit which is now with Fifth Third. The balance has increased $706,043 since December 31, 2006 as a result of draws made in June and September. The proceeds were used for the general operating expenses of the Company and to contribute capital to the Bank to ensure that it maintained a well-capitalized regulatory status. Future draws are expected for similar reasons. Shareholders' equity totaled $16.4 million and $16.1 million at September 30, 2007 and December 31, 2006 respectively. The increase consists of earnings recorded in the first nine months of the year, a decrease in accumulated other comprehensive loss (security market value adjustments) and one stock option exercise. RESULTS OF OPERATIONS The net income for the first nine months of 2007 was $143,000 which was $925,000 less than the similar period in 2006. The corresponding basic and diluted earnings per share for the first nine months of 2007 was $0.10 compared to $0.74 and $0.73 respectively for 2006. Year to date 2007 earnings were impacted by a lower net interest margin coupled with higher loan loss provision and higher personnel and depreciation costs associated with two new branch buildings--one in a new market and one replacement building and the undertaking of a mortgage initiative. The Company recorded a $103,000 net loss for the third quarter of 2007 while the same period in 2006 netted earnings of $363,000. The corresponding basic and diluted earnings per share for the third quarter of 2007 were -$0.07 compared to $0.25 for the similar period in 2006. These results are indicative of the higher loan loss provision as well as the significant investments the Company has made in branch facilities over the past nine months and the second quarter recruitment of five mortgage originators and support staff. Rising loan loss provision expense is directly related to the weak Michigan economy and its effect on real estate values and businesses throughout the state. The branching strategy is working as evidenced by an increase in deposit market share however there is still progress to be made in the way of gathering lower costing funds and improving the Bank's net interest margin. The mortgage strategy has had inconsistent returns, and in addition to being beset with start up costs, there have been the added challenges of the current real estate market and the declining pool of secondary market investors. For the first nine months and third quarter of 2007, the annualized return on the Company's average total assets was 0.07% and -0.15%, respectively, which is down from 0.62% annualized return for both of the same periods in 2006. The Company's annualized return on -19- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS average equity was 1.17% and -2.51% for the first nine months and third quarter of 2007 and 9.42% and 9.33% for the first nine months and third quarter of 2006. The ratio of average equity to average assets was 6.41% and 6.21% for the first nine months and third quarter of 2007 and 6.60% and 6.67% for the same periods in 2006. As mentioned above, significant differences between the operating results of the first nine months of 2006 and 2007 are the net interest income and the corresponding net interest margin. The following table sets forth certain information relating to the Company's consolidated average interest earning assets and interest bearing liabilities and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing annualized income or expenses by the average daily balance of assets or liabilities, respectively, for the periods presented.
Nine months ended September 30, --------------------------------------------------------------------------- 2007 2006 ------------------------------------ ------------------------------------ Average Average Average Average Balance Interest Rate Balance Interest Rate ------------ ----------- ------- ------------ ----------- ------- Assets Federal funds sold and interest- bearing deposits with other financial institutions $ 3,101,880 $ 121,238 5.21% $ 3,720,311 $ 126,834 4.55% Securities 19,421,139 718,767 4.93 19,430,919 621,798 4.27 Loans (including held for sale and non accrual) 216,205,928 12,844,252 7.92 196,017,819 11,468,639 7.80 ------------ ----------- ------ ------------ ----------- ------ 238,728,947 13,684,257 7.64 219,169,049 12,217,271 7.43 Other assets 16,441,876 10,198,478 ------------ ------------ $255,170,823 $229,367,527 ============ ============ Liabilities and Shareholders' Equity Interest-bearing deposits $199,874,672 $ 6,628,072 4.42 $177,886,277 $ 5,050,865 3.79 Federal funds purchased, repur-- chase agreements and Federal Reserve Bank borrowings 8,820,177 279,755 4.23 7,488,944 218,640 3.89 Subordinated Debentures, Note Payable and Federal Home Loan Bank Advances 11,041,557 546,643 6.60 10,704,396 515,328 6.42 ------------ ----------- ------ ------------ ----------- ------ 219,736,406 7,454,470 4.52 196,079,617 5,784,833 3.93 ----------- ----------- Non-interest bearing deposits 18,193,034 17,564,795 Other liabilities 875,926 589,265 Shareholders' Equity 16,365,457 15,133,850 ------------ ------------ $255,170,823 $229,367,527 ============ ============ Net interest income (tax equivalent basis) 6,229,787 6,432,438 Net interest spread on earning assets (tax equivalent basis) 3.12% 3.50% ====== ====== Net interest margin on earning assets (tax equivalent basis) 3.48% 3.91% ====== ====== Average interest-earning assets to average interest-bearing liabilities 108.64% 111.78% ====== ====== Tax equivalent adjustment 85,876 80,517 ----------- ----------- Net interest income $ 6,143,911 $ 6,351,921 =========== ===========
-20- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS The tax equivalent net interest spread on average earning assets decreased 38 basis points to 3.12% since September 30, 2006. The tax equivalent net interest margin decreased by 43 basis points from 3.91% at September 30, 2006 to 3.48% at September 30, 2007. The tax equivalent net interest income for the first nine months of 2007 was $6.2 million compared to a figure of $6.4 million for the same nine months in 2006. The Company recorded $208,000 less net interest income although there were $19.6 million more average earning assets on the books. The net interest margin compression between the two periods was mostly a result of increased cost of funds between the first nine months of 2006 compared to the similar period in 2007. Relative increases to loan income from higher internal prime lending rates and more average loans outstanding were not enough to offset the 59 basis point increase in expense experienced on the deposit side from a rate and outstanding balance perspective. The average rate earned on interest earning assets was 7.64% for the nine months ended September 30, 2007 compared to 7.43% for the same period in 2006. The main contributing factor was a 12 basis point increase in the yield on loans, the Bank's largest earning asset category. The Bank's internal prime rate was 37 basis points higher between the first nine months of 2007 and that of 2006. Internal prime rate changes, no matter what direction, affect interest earned on variable rate loans and new loan volume. Typically the Bank's loan portfolio is fairly balanced between fixed and floating rate loans however over the last year customers have preferred fixed rate terms causing the concentration of floating rate loans to be reduced to 42% as of September 30, 2007. As of September 30, 2006 the concentration was 48%. This reduction of floating rate loans is helpful to net interest income in a downward rate environment such as the one we are experiencing. Interest expense incurred on deposits, repurchase agreements, federal funds purchased, Federal Home Loan Bank advances and Notes Payable increased by 59 basis points for the first nine months of 2007 compared to the first nine months of 2006. During 2006, there was a significant lag between the timing of loan rate increases and increases in the Bank's cost of funds. For the first nine months of 2007, deposit rates continued to rise while lending rates remained stable. Now that lending rates are decreasing there may be opportunities to reduce the Bank's cost of funds, particularly in its time deposit portfolio. In the next ninety days there will be $38 million of time deposits repricing. The average rate on these deposits is currently 5.15%. Based on the current treasury yield curve and local competition, it is likely that these deposits will reprice on average 40-60 basis points less. Although this is helpful in the short term it is management's long term goal for the Bank's branching system to attract lower costing funds adjusting the mix of the Bank's outstanding deposits towards one that has less dependence on large time deposits, particularly those that are brokered. Achieving this should positively affect the Company's net interest margin. -21- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS The quarter-to-quarter comparison of consolidated average interest earning assets and interest bearing liabilities and average yield on assets and average cost of liabilities for the third quarter ended September 30, 2007 and 2006 is in the table below.
Three months ended September 30, -------------------------------------------------------------------------- 2007 2006 ------------------------------------ ------------------------------------ Average Average Average Average Balance Interest Yield/Rate Balance Interest Yield/Rate ------------ ---------- ---------- ------------ ---------- ---------- Assets Federal funds sold and interest-bearing deposits with other financial institutions $ 253,603 $ 2,898 4.57% $ 566,559 $ 7,095 5.01% Securities 19,269,696 241,190 5.01 19,201,745 208,480 4.34 Loans (including held for sale and non accrual) 227,545,720 4,518,411 7.94 202,431,823 4,098,809 8.10 ------------ ---------- ------ ------------ ---------- ------ 247,069,019 4,762,499 7.71 222,200,127 4,314,384 7.77 Other assets 17,043,335 11,199,417 ------------ ------------ $264,112,354 $233,399,544 ============ ============ Liabilities and Shareholders' Equity Interest-bearing deposits $204,710,229 $2,306,697 4.51 $178,115,917 $1,833,631 4.12 Federal funds purchased, repur-chase agreements and Federal Reserve Bank borrowings 12,187,580 139,248 4.57 9,636,852 107,957 4.48 Subordinated Debentures, Note Payable and Federal Home Loan Bank Advances 11,311,359 189,736 6.71 10,828,261 181,588 6.71 ------------ ---------- ------ ------------ ---------- ------ 228,209,168 2,635,681 4.62 198,581,030 2,123,176 4.28 ---------- ---------- Non-interest bearing deposits 18,830,177 18,377,412 Other liabilities 662,480 872,117 Shareholders' Equity 16,410,529 15,568,985 ------------ ------------ $264,112,354 $233,399,544 ============ ============ Net interest income (tax equivalent basis) 2,126,818 2,191,208 Net interest spread on earning assets (tax equivalent basis) 3.09% 3.49% ====== ====== Net interest margin on earning assets (tax equivalent basis) 3.44% 3.94% ====== ====== Average interest-earning assets to average interest-bearing liabilities 108.26% 111.89% ====== ====== Tax equivalent adjustment 28,103 27,239 ---------- ---------- Net interest income $2,098,715 $2,163,969 ========== ==========
Similar to the comparison of the net interest income results of the first nine months of 2006 to that of the first nine months of 2007, there was a decrease in tax equivalent net interest income between the two quarters and there was net interest margin compression. Tax equivalent net interest income decreased by $64,000 in spite of the fact that there was $24.9 million more average earning assets between the third quarter of 2007 and the third quarter of 2006. The tax equivalent net interest spread and margin declined by 40 and 50 basis points respectively between the third quarter of 2006 and the similar period in 2007. The results were the effect of both a decline in the yield earned on interest earning assets between the two periods coupled with a 34 basis point increase in the Company's cost of funds between the third quarter of 2006 and that of 2007. -22- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS As the Bank's cost of funds increases and prime rate changes are always a possibility, asset liability management has become an important tool for assessing and monitoring liquidity and interest rate sensitivity. Liquidity management involves the ability to meet the cash flow requirements of the Company's customers. These customers may be either borrowers with credit needs or depositors wanting to withdraw funds. Management of interest rate sensitivity attempts to avoid widely varying net interest margins and achieve consistent net interest income through periods of changing interest rates. Asset liability management assists the Company in realizing reasonable and predictable earnings and liquidity by maintaining a balance between interest-earning assets and interest-bearing liabilities. The Company uses a sophisticated computer program to perform analysis of interest rate risk, assist with asset liability management, and model and measure interest rate sensitivity. Interest rate sensitivity varies with different types of earning assets and interest-bearing liabilities. Overnight investments, of which rates change daily, and loans tied to the prime rate, differ considerably from long term investment securities and fixed rate loans. Interest bearing checking and money market accounts are more interest sensitive than long term time deposits and fixed rate FHLB advances. Comparison of the repricing intervals of interest earning assets to interest bearing liabilities is a measure of interest sensitivity gap. Balancing this gap is a continual challenge in a highly competitive and changing rate environment. Details of the repricing gap at September 30, 2007 were:
Interest Rate Sensitivity Period ----------------------------------------------------------------------- Within Three to One to After Three Twelve Five Five Months Months Years Years Total ------------ ------------ ------------ ----------- ------------ Earning assets Interest-bearing deposits in other financial institutions $ 66,121 $ 0 $ 0 $ 0 $ 66,121 Federal Funds Sold 0 0 0 0 0 Securities (including FHLB stock) 1,043,095 1,477,618 10,624,474 6,057,494 19,202,681 Loans Held for Sale 0 0 0 921,623 921,623 Loans(1) 104,858,167 18,971,712 91,370,291 14,770,195 229,970,365 ------------ ------------ ------------ ----------- ------------ 105,967,383 20,449,330 101,994,765 21,749,312 250,160,790 Interest-bearing liabilities Savings and checking 55,754,500 0 0 0 55,754,500 Time deposits <$100,000 12,600,684 25,507,758 6,558,205 0 44,666,647 Time deposits >$100,000 25,350,956 46,289,383 34,978,636 0 106,618,975 Repurchase agreements and Federal funds purchased 13,506,499 0 0 0 13,506,499 Subordinated Debt and Federal Home Loan Bank Advances 11,606,043 0 0 0 11,606,043 ------------ ------------ ------------ ----------- ------------ 118,818,682 71,797,141 41,536,841 0 232,152,664 Net asset (liability) repricing gap $(12,851,299) $(51,347,811) $ 60,457,924 $21,749,312 $ 18,008,126 ============ ============ ============ =========== ============ Cumulative net asset (liability) Repricing gap $(12,851,299) $(64,199,110) $ (3,741,186) $18,008,126 ============ ============ ============ ===========
---------- (1) Includes non accrual loans. -23- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS Currently the Company has a negative twelve month repricing gap which indicates that the Company is liability sensitive in the next twelve month period. This position implies that decreases to the national federal funds rate would have more of an impact on interest expense than on interest income during this period if there were a parallel shift in rates. For instance if the Company's internal prime rate went down by 25 basis points and every interest earning asset and interest bearing liability on the Company's September 30, 2007 balance sheet repricing in the next twelve months adjusted simultaneously by the same 25 basis points, more liabilities would be affected than assets. Theoretically the current declining rate environment should have a positive affect on net interest income and earnings. The unknown factor is the effect of local pricing from competitors and the exact timing of deposit repricing lags. The provision for loan losses for the third quarter and the first nine months of 2007 were $407,000 and $802,000 compared to figures of $217,000 and $519,000 for the same periods in 2006. The increase in the provision expense is not only related to new loan growth but it is also related to the increase in non performing and troubled credits that have been identified. The ratio of non-performing loans(1) as a percentage of total loans has nearly doubled in the last twelve months. The increased provision expense has made the ratio of the allowance for loan losses to total loans increase by 12 basis points to a level of 1.35%. Management believes that the allowance level is adequate and justified based on the factors discussed earlier (see Financial Condition). Management will continue to review the allowance with the intent of maintaining it at an appropriate level. The provision may be increased or decreased in the future as management continues to monitor the loan portfolio and actual loan loss experience. Non-interest income recorded in the first nine months of 2007 totaled $1.3 million and represented a 14% increase compared to last year's first nine months total, which was $1.1 million. The main underlying factor was an increase in gains on mortgage loan sales recorded. In the first nine months of 2007, the gains on sales of these products totaled $113,000 compared to $22,000 recorded in the first nine months of 2006. Gains on sales of SBA loans were $16,000 more for the first nine months of 2007 compared to the same period in 2006. Increases to gain on loan sales were offset by a $21,000 decline in fees earned on the Bank's overdraft protection product mostly caused by lower commercial customer usage than in the past. Non-interest income for the third quarter of 2007 was $43,000 less than the $461,000 recorded in the same quarter of 2006. A significant portion of the decrease is derived from differences in gains on SBA loan sales. There were no gains recorded in the third quarter of 2007 compared to $121,000 recorded in the third quarter of 2006. Non-interest expenses for the first nine months of 2007 were $6.5 million compared to a total of $5.4 million for 2006, an increase of 20%. The third quarter non-interest expense total was $2.3 million for 2007 and $1.9 million for 2006. The notable variances among the individual categories were in the areas of salaries and benefits and occupancy and equipment expenses. On average there were an additional 19 full-time equivalent employees during the first nine months of 2007 compared to the same period of 2006. These additions as well as general staff compensation increases resulted in a 27% growth in total salaries and benefits expense. ---------- (1) Non performing loans are defined as those that are past due 90 days or more or are on non accrual. -24- COMMUNITY SHORES BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS Additions to staff were made for the newly created fourth branch facility as well as to support the growth of the Bank from both a sales and operational standpoint. The recently implemented mortgage initiative added nine full-time equivalent employees in the second quarter of 2007. There were associated recruiting costs for this effort. The $780,000 increase in salaries and benefits between the first nine months of 2007 and the similar period in 2006 accounted for 14% of the increase in total non interest expenses. For the third quarter of 2007, salaries and benefits were $296,000 higher than the similar period in 2006. For that period the difference in full-time equivalent people was 20. The salaries and benefits expenses recorded for the third quarter of 2007 included recruiting expenses associated with the mortgage initiative. At this time, the Bank is planning to move the five mortgage originators currently on staff to a more commissioned-based compensation program. Occupancy and equipment expenses were $911,000 and $318,000 for the first nine months and third quarter of 2007 respectively compared to $587,000 and $214,000 for the first nine months and third quarter of 2006. The increases between the four periods is directly related to depreciation expense from the construction of a fourth banking location which became operational in the fourth quarter of 2006 as well as the construction of a replacement banking facility in North Muskegon which opened in January of 2007. In August, the Grand Haven location construction was completed and the branch was relocated to its new facility. Going forward equipment expenses will rise as a result. It is not anticipated that occupancy expenses will be affected as a result of the Grand Haven branch because the building depreciation costs are offset by the cessation of rental payments. Other non interest expenses were $400,000 for the third quarter of 2007, an increase of $70,000 compared to the $329,000 recorded in the same quarter of 2006. In the third quarter of 2007, the Bank incurred increased FDIC fees of approximately $34,000 because of a surcharge that was instituted by the FDIC in the third quarter to force newly chartered banks to pay into their reserve fund. It is not known how long the surcharge will be in effect. Mortgage loan related expenses increased as a result of more originations. Federal tax expense was lower in the first nine months of 2007 compared to the first nine months of 2006. The decrease is not only related to lower pre-tax income but also to an adjustment that occurred in the first quarter of 2007 when the Company reevaluated its federal tax accruals and concluded that tax liabilities needed to be modified reducing federal tax expense recorded in that quarter by $36,000. The federal tax benefit that was recorded in the third quarter of 2007 was due to the proportion of tax free municipal bond income to consolidated pre-tax income. -25- COMMUNITY SHORES BANK CORPORATION ITEM 3. CONTROLS AND PROCEDURES An evaluation was carried out under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of September 30, 2007. Based on the evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures were, to the best of their knowledge, effective as of September 30, 2007 with respect to information required to be disclosed by the Company in reports that it files or submits under the Exchange Act. No change in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time, the Company, the Bank, the Mortgage Company or Community Shores Financial Services may be involved in various legal proceedings that are incidental to their business. In the opinion of management, the Company, the Bank, the Mortgage Company and Community Shores Financial Services are not a party to any current legal proceedings that are material to their financial condition, either individually or in the aggregate. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION Not applicable. -26- COMMUNITY SHORES BANK CORPORATION ITEM 6. EXHIBITS
EXHIBIT NO. EXHIBIT DESCRIPTION ----------- ----------------------------------------------------------------- 3.1 Articles of Incorporation of the Company are incorporated by reference to exhibit 3.1 of the Company's June 30, 2004 Form 10-QSB (SEC file number 333-63769) 3.2 Bylaws of the Company are incorporated by reference to exhibit 3(ii) of the Company's Form 8-K filed July 5, 2006 (SEC file number 000-51166) 10.1 Loan Agreement between Community Shores Bank Corporation and Fifth Third Bank dated September 7, 2007 31.1 Rule 13a-14(a) Certification of the principal executive officer 31.2 Rule 13a-14(a) Certification of the principal financial officer 32.1 Section 1350 Certification of Chief Executive Officer 32.2 Section 1350 Certification of Chief Financial Officer
-27- SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 14, 2007. COMMUNITY SHORES BANK CORPORATION By: /s/ Heather D Brolick ------------------------------------ Heather D. Brolick President and Chief Executive Officer (principal executive officer) By: /s/ Tracey A. Welsh ------------------------------------ Tracey A. Welsh Senior Vice President, Chief Financial Officer and Treasurer (principal financial and accounting officer) -28- EXHIBIT INDEX
EXHIBIT NO. EXHIBIT DESCRIPTION ----------- ----------------------------------------------------------------- 3.1 Articles of Incorporation of the Company are incorporated by reference to exhibit 3.1 of the Company's June 30, 2004 Form 10-QSB (SEC file number 333-63769) 3.2 Bylaws of the Company are incorporated by reference to exhibit 3(ii) of the Company's Form 8-K filed July 5, 2006 (SEC file number 000-51166) 10.1 Loan Agreement between Community Shores Bank Corporation and Fifth Third Bank dated September 7, 2007 31.1 Rule 13a-14(a) Certification of the principal executive officer 31.2 Rule 13a-14(a) Certification of the principal financial officer 32.1 Section 1350 Certification of Chief Executive 32.2 Section 1350 Certification of Chief Financial Officer
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