UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012 _____________________________________________________                                                                                     

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____________________________ to ________________________________

Commission File Number:     000-51166

Community Shores Bank Corporation
(Exact name of registration as specified in its charter)
Michigan	38-3423227
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
1030 W. Norton Avenue, Muskegon, MI	49441
(Address of principal executive offices)	(Zip Code)
(231) 780-1800
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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.

                                                                                                                                                                 xYes oNo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

                                                                                                                                                                            oYes  xNo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  oAccelerated filero       Non-accelerated filer o                         Smaller reporting company x

                                                                                  (Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

                                                                                                                                                                 oYes xNo

At November 1, 2012, 1,468,800 shares of common stock were outstanding.

Community Shores Bank Corporation Index

PART I.	Financial Information	Page No.
	Item 1.   Financial Statements (Unaudited)	1
	Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
	Item 3.   Quantitative and Qualitative Disclosures about Market Risk	54
	Item 4.   Controls and Procedures	54
PART II.	Other Information
	Item 1.   Legal Proceedings	55
	Item 1A. Risk Factors	55
	Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds	55
	Item 3.   Defaults upon Senior Securities	56
	Item 4.   Mine Safety Disclosures	56
	Item 5.   Other Information	56
	Item 6.   Exhibits	56
	Signatures	57

PART I – FINANCIAL INFORMATION

ITEM 1.                      FINANCIAL STATEMENTS (UNAUDITED)

COMMUNITY SHORES BANK CORPORATION

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

	September 30,			December 31,
	2012			2011
	(unaudited)
ASSETS
Cash and due from financial institutions	$	2,774,023		$	2,426,142
Interest-bearing deposits in other financial institutions		24,661,503			6,493,426
Total cash and cash equivalents		27,435,526			8,919,568
Securities available for sale (at fair value)		38,208,538			34,572,103
Loans held for sale		6,036,464			5,534,983
Loans		125,234,631			149,658,931
Less: Allowance for loan losses		3,603,407			5,299,454
Net loans		121,631,224			144,359,477
Federal Home Loan Bank stock (at cost)		450,800			450,800
Premises and equipment, net		9,469,098			10,404,865
Accrued interest receivable		650,613			746,143
Foreclosed assets		2,993,531			3,276,838
Other assets		846,001			386,524
Total assets	$	207,721,795		$	208,651,301
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Non-interest-bearing	$	45,158,043		$	33,281,198
Interest-bearing		144,136,089			158,264,038
Total deposits		189,294,132			191,545,236
Federal funds purchased and repurchase agreements		8,593,208			7,814,745
Subordinated debentures		4,500,000			4,500,000
Notes payable		5,000,000			5,000,000
Accrued expenses and other liabilities		1,483,997			1,211,702
Total liabilities		208,871,337			210,071,683
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 issued and outstanding		13,296,691			13,296,691
Retained deficit		(14,824,949	)		(15,084,431	)
Accumulated other comprehensive income		378,716			367,358
Total shareholders’ equity		(1,149,542	)		(1,420,382	)
Total liabilities and shareholders’ equity	$	207,721,795		$	208,651,301

See accompanying notes to consolidated financial statements.

- 1 -

COMMUNITY SHORES BANK CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

	Three Months		Three Months			Nine Months			Nine Months
	Ended		Ended			Ended			Ended
	September 30,		September 30,			September 30,			September 30,
	2012		2011			2012			2011
Interest and dividend income
Loans, including fees	$	1,946,158	$	2,467,854		$	6,199,527		$	7,567,907
Securities (including FHLB dividends)		162,014		189,988			511,709			608,180
Federal funds sold and other income		15,841		15,958			39,456			48,918
Total interest income		2,124,013		2,673,800			6,750,692			8,225,005
Interest expense
Deposits		333,829		725,662			1,094,497			2,302,079
Repurchase agreements, federal funds purchased, and other debt		15,574		20,583			54,593			52,200
Federal Home Loan Bank advances and notes payable		108,093		104,742			322,937			311,793
Total interest expense		457,496		850,987			1,472,027			2,666,072
Net Interest Income		1,666,517		1,822,813			5,278,665			5,558,933
Provision for loan losses		0		344,692			75,035			1,547,118
Net Interest Income After Provision for Loan Losses		1,666,517		1,478,121			5,203,630			4,011,815
Non-interest income
Service charges on deposit accounts		166,975		180,605			505,783			555,252
Mortgage loan referral fees		0		23,251			14,441			35,356
Gain on sale of loans		105,455		23,701			208,387			194,883
Gain on sale of securities		0		3,288			2,856			3,288
Gain (loss) on sale of foreclosed assets		2,375		201,086			(40,058	)		196,018
Gain on sale of premises and equipment		0		0			208,389			0
Other		144,153		154,343			395,606			481,172
Total non-interest income		418,958		586,274			1,295,404			1,465,969
Non-interest expense
Salaries and employee benefits		939,795		1,017,631			2,828,517			3,070,062
Occupancy		163,266		166,958			484,751			503,804
Furniture and equipment		101,243		137,114			305,228			406,115
Advertising		14,198		16,023			41,550			36,958
Data processing		142,929		122,219			425,390			372,832
Professional services		70,695		78,085			218,803			258,022
Foreclosed asset impairment		92,428		645,797			277,448			1,038,725
Other		558,974		565,931			1,657,865			1,733,167
Total non-interest expense		2,083,528		2,749,758			6,239,552			7,419,685
Income (Loss) Before Federal Income Taxes		1,947		(685,363	)		259,482			(1,941,901	)
Federal income tax expense (benefit)		0		0			0			0
Net Income (Loss)	$	1,947	$	(685,363	)	$	259,482		$	(1,941,901	)
Weighted average shares outstanding		1,468,800		1,468,800			1,468,800			1,468,800
Diluted average shares outstanding		1,468,800		1,468,800			1,468,800			1,468,800
Basic earnings (loss) per share	$	0	$	(0.47	)	$	0.18		$	(1.32	)
Diluted earnings (loss) per share	$	0	$	(0.47	)	$	0.18		$	(1.32	)

See accompanying notes to consolidated financial statements.

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COMMUNITY SHORES BANK CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

	Three Months		Three Months			Nine Months			Nine Months
	Ended		Ended			Ended			Ended
	September 30, 2012		September 30, 2011			September 30, 2012			September 30, 2011
Net income (loss)	$	1,947	$	(685,363	)	$	259,482		$	(1,941,901	)
Other comprehensive income:
Unrealized holding gains on
available for sale securities		38,745		53,763			14,214			278,699
Less reclassification adjustments for gains
later recognized in income		0		(3,288	)		(2,856	)		(3,288	)
Net unrealized gain		38,745		50,475			11,358			275,411
Tax effect		0		0			0			0
Total other comprehensive income		38,745		50,475			11,358			275,411
Comprehensive income (loss)	$	40,692	$	(634,888	)	$	270,840		$	(1,666,490	)

See accompanying notes to consolidated financial statements.

- 3 -

COMMUNITY SHORES BANK CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

								Accumulated
								Other		Total
			Common		Retained			Comprehensive		Shareholders’
	Shares		Stock		Deficit			Income		Equity
Balance at January 1, 2011		1,468,800	$	13,296,691	$	(12,617,022	)	$	166,118	$	845,787
Net loss						(1,941,901	)				(1,941,901	)
Other comprehensive income									275,411		275,411
Balance at September 30, 2011		1,468,800	$	13,296,691	$	(14,558,923	)	$	441,529	$	(820,703	)
Balance at January 1, 2012		1,468,800	$	13,296,691	$	(15,084,431	)	$	367,358	$	(1,420,382	)
Net income						259,482					259,482
Other comprehensive income									11,358		11,358
Balance at September 30, 2012		1,468,800	$	13,296,691	$	(14,824,949	)	$	378,716	$	(1,149,542	)

See accompanying notes to consolidated financial statements.

- 4 -

COMMUNITY SHORES BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOW

(UNAUDITED)

	Nine Months Ended			Nine Months Ended
	September 30, 2012			September 30, 2011
Cash flows from operating activities
Net income (loss)	$	259,482		$	(1,941,901	)
Adjustments to reconcile net income (loss) to net cash
from operating activities:
Provision for loan losses		75,035			1,547,118
Depreciation and amortization		301,960			397,871
Net amortization of securities		229,564			185,213
Net realized gain on sale of securities		(2,856	)		(3,288	)
Net realized gain on sale of loans		(208,387	)		(194,883	)
Net realized gain on sale of premises and equipment		(208,389	)		0
Net realized (gain) loss on sale of foreclosed assets		40,058			(196,018	)
Foreclosed asset impairment		277,448			1,038,725
Originations of loans for sale		(11,657,459	)		(12,687,831	)
Proceeds from loan sales		11,364,365			7,934,274
Net change in:
Accrued interest receivable and other assets		(363,947	)		178,659
Accrued interest payable and other liabilities		272,295			115,712
Net cash from (used in) operating activities		379,169			(3,626,349	)
Cash flows from investing activities
Activity in available for sale securities:
Sales		257,997			820,285
Maturities, prepayments and calls		8,331,960			11,892,365
Purchases		(12,441,742	)		(12,638,990	)
Loan originations and payments, net		21,481,939			9,423,390
Redemption of Federal Home Loan Bank stock		0			29,000
Proceeds from the sale of premises and equipment		998,524			0
Additions to premises and equipment, net		(156,328	)		(47,618	)
Proceeds from the sale of foreclosed assets		1,137,080			283,883
Net cash from investing activities		19,609,430			9,762,315
Cash flows from financing activities
Net change in deposits		(2,251,104	)		(19,938,898	)
Net change in federal funds purchased and
repurchase agreements		778,463			2,321,594
Net cash used in financing activities		(1,472,641	)		(17,617,304	)
Net change in cash and cash equivalents		18,515,958			(11,481,338	)
Beginning cash and cash equivalents		8,919,568			23,639,873
Ending cash and cash equivalents	$	27,435,526		$	12,158,535
Supplemental cash flow information:
Cash paid during the period for interest	$	1,156,813		$	2,391,758
Transfers from loans to foreclosed assets		1,243,347			876,597
Foreclosed asset sales financed by the Company		72,068			427,440

See accompanying notes to consolidated financial statements.

- 5 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  BASIS OF PRESENTATION AND RECENT DEVELOPMENTS:

The unaudited, consolidated financial statements as of and for the three and nine month periods ended September 30, 2012 include the consolidated results of operations of Community Shores Bank Corporation (“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”) and the Mortgage Company’s wholly-owned subsidiary, Berryfield Development, LLC (“Berryfield”). Community Shores Capital Trust I (“the Trust”) is not consolidated and exists solely to issue capital securities. These consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Article 8 of Regulation S-X 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, 2012 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-K for the period ended December 31, 2011. Some items in the prior year financial statements may be reclassified to conform to the current presentation.

In May 2011, the FASB issued an amendment to achieve common fair value measurement and disclosure requirements between U.S. and International accounting principles. Overall, the guidance is consistent with existing U.S. accounting principles; however, there are some amendments that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements.  For public companies, the amendments in this guidance are effective for interim and annual reporting periods beginning after December 15, 2011. The effect of adopting this new guidance was disclosure-related only and had no impact on the Company’s results of operations.

In June 2011, the FASB amended existing guidance and eliminated the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity. The amendment requires that comprehensive income be presented in either a single continuous statement or in two separate consecutive statements.  For public companies, the amendments in this guidance are effective as of the beginning of a fiscal reporting year, and interim periods within that year, that begins after December 15, 2011. The Company adopted this amendment by adding a consolidated statement of comprehensive income immediately following the consolidated statements of income.

- 6 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION AND RECENT DEVELOPMENTS (Continued):

Since 2008, the Company has experienced consolidated losses stemming from deterioration in credit quality and real estate values requiring the need for large loan loss provisions and impairments of foreclosed real estate. As a result primarily of the sustained losses, the Bank’s capital ratios declined. The Bank has been deemed undercapitalized since December 31, 2010 according to regulatory capital standards. At that time, the Bank had a total risk-based capital ratio of 7.06%. In 2012, after three quarters of profitability and a reduction of higher risk-weighted assets, the Bank’s total risk- based capital ratio increased to 7.80%. In spite of the improving total risk-based capital ratio, the Bank remains undercapitalized as of September 30, 2012.

As a result of deteriorating asset quality, poor earnings and falling capital ratios, the Bank endured additional regulatory scrutiny and entered into a Consent Order with the Federal Deposit Insurance Corporation (“FDIC”) and the State of Michigan’s Office of Financial and Insurance Regulation (“OFIR”), its primary regulators, on September 2, 2010. The Bank agreed to the terms of the Consent Order without admitting or denying any charge of unsafe or unsound banking practices relating to capital, asset quality, or earnings. The Consent Order imposes no fines or penalties on the Bank. The Consent Order will remain in effect and enforceable until it is modified, terminated, suspended, or set aside by the FDIC and OFIR. Under the Consent Order the Bank was required, within 90 days of September 2, 2010, to have and maintain its level of Tier 1 capital, as a percentage of its total assets, at a minimum of 8.5%, and its level of qualifying total capital, as a percentage of risk-weighted assets, at a minimum of 11%. The Bank was not able to meet these requirements within the required 90-day period and remains out of compliance with the Consent Order as of September 30, 2012.

The lack of financial soundness of the Bank and the Company’s inability to serve as a source of strength for the Bank resulted in the board of directors entering into a Written Agreement with the Federal Reserve Bank of Chicago (the “FRB”), the Company’s primary regulator. The Written Agreement became effective on December 16, 2010, when it was executed by the FRB. The Written Agreement provides that: (i) the Company must take appropriate steps to fully utilize its financial and managerial resources to serve as a source of strength to the Bank; (ii) the Company may not declare or pay any dividends or take dividends or any other payment representing a reduction in capital from the Bank or make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior FRB approval; (iii) the Company may not incur, increase or guarantee any debt or purchase or redeem any shares of its stock without prior FRB approval; (iv) the Company must submit a written statement of its planned sources and uses of cash for debt service, operating expenses and other purposes to the FRB within 30 days of the Written Agreement; (v) the Company shall take all necessary actions to ensure that the Bank, the Company and all nonbank subsidiaries of both the Bank and the Company comply with sections 23A and 23B of the Federal Reserve Act and Regulation W of the Board of Governors (12 C.F.R. Part 223) in all transactions between affiliates; (vi) the Company may not appoint any new director or senior executive officer, or change the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position, without prior regulatory approval; and finally (vii) within 30 days after the end of each calendar quarter following the date of the Written Agreement, the board of directors shall submit to the FRB written progress reports detailing the form and manner of all actions taken to secure compliance with the provisions of the Written Agreement as well as current copies of the parent company only financial statements. The Company has not yet been able to meet the obligation detailed in part (i) above; as the Company currently has negative equity and limited resources with which to support the capital needs of the Bank.

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COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION AND RECENT DEVELOPMENTS (Continued):

The Company’s main liquidity resource is its cash account balance which, as of September 30, 2012, was approximately $32,000. At this time, the Company has chosen to postpone the decision to take advantage of the Jumpstart Our Business Startups Act (the “JOBS Act”) and deregister as a public company. Management and the Board of Directors are considering many options for obtaining funding for the Company and do not believe it would be in the best interest of the Company to limit its options by deregistering. It is projected that the level of cash held at September 30, 2012 is adequate to support the Company’s overhead expenses through year-end 2012.
 

On January 3, 2011, the Company was not able to repay its $5 million term loan when it came due. The Company does not have the resources to pay the outstanding principal and does not expect to have it in the near future. The Company did not make the last ten contractual quarterly interest payments. The total interest due to Fifth Third at year-end 2011 was $458,000. The Company continues to accrue interest on the term loan and at September 30, 2012, the total interest due Fifth Third was $686,000. Since the Company presently does not have sufficient funds to pay off the term loan’s principal and accrued interest, Fifth Third has a right to foreclose on the Bank’s stock which collateralizes the term loan.

On August 17, 2011, the Bank was issued a Supervisory Prompt Corrective Action Directive (the “Directive”) because of its undercapitalized capital category at December 31, 2010, its failure to submit a capital restoration plan that satisfies the requirements stipulated in the FDIC Rules and Regulations, and the continued deterioration of the Bank. The Directive stipulated that the Bank be restored to an “adequately capitalized” capital category within 60 days of the issuance of the Directive. During the 60 days, the board made efforts to secure funding and comply with the Directive but was not successful. As such, the Bank was not in compliance with the Directive at the end of 60 days and remains out of compliance. The board informed the FDIC in a letter dated October 14, 2011 that it was unable to comply with the Directive. There has been no further communications with the FDIC regarding the Directive. The board’s efforts to garner capital for the Bank are expected to continue.

Failure to comply with the provisions of the Consent Order, the Written Agreement or the Directive may subject the Bank to further regulatory enforcement action.

The Company’s net losses, failure to repay its term loan at maturity, non-compliance with the higher capital ratios of the Directive and the Consent Order, and the provisions of the Written Agreement raise substantial doubt about the Company’s ability to continue as a going concern. As a result of this substantial doubt, our auditors added an explanatory paragraph to their opinion on the Company’s December 31, 2011 and 2010 consolidated financial statements expressing substantial doubt about the Company’s ability to continue as a going concern. These financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

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COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2.  SECURITIES AVAILABLE FOR SALE:

The following tables represent the securities held in the Company’s portfolio at September 30, 2012 and at December 31, 2011:

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
September 30, 2012	Cost		Gains		Losses			Value
US Treasury	$	4,550,577	$	57,470	$	0		$	4,608,047
US Government and federal agency		18,528,866		282,751		(81	)		18,811,536
Municipals		2,262,070		88,604		0			2,350,674
Mortgage-backed and collateralized
mortgage obligations– residential		12,167,411		297,248		(26,378	)		12,438,281
	$	37,508,924	$	726,073	$	(26,459	)	$	38,208,538

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
December 31, 2011	Cost		Gains		Losses			Value
US Treasury	$	4,041,881	$	25,775	$	0		$	4,067,656
US Government and federal agency		15,341,362		239,037		(7,811	)		15,572,588
Municipals		2,767,463		123,957		0			2,891,420
Mortgage-backed and collateralized
mortgage obligations– residential		11,733,141		317,565		(10,267	)		12,040,439
	$	33,883,847	$	706,334	$	(18,078	)	$	34,572,103

The amortized cost and fair value of the securities portfolio are shown by expected maturity.  Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment fees.  Below is the schedule of contractual maturities for securities held at September 30, 2012:

	Amortized		Fair
	Cost		Value
Due in one year or less	$	5,526,468	$	5,568,339
Due from one to five years		18,211,886		18,523,784
Due from five to ten years		1,603,159		1,678,134
Due in more than ten years		0		0
Mortgage-backed and collateralized
mortgage obligations – residential		12,167,411		12,438,281
	$	37,508,924	$	38,208,538

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COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2.  SECURITIES AVAILABLE FOR SALE (Continued):

Below is the table of securities with unrealized losses, aggregated by investment category and length of time such securities were in an unrealized loss position at September 30, 2012 and December 31, 2011:

	Less than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
September 30, 2012	Value		Losses			Value		Losses			Value		Losses
US Government and federal agency	$	529,612	$	(81	)	$	0	$	0		$	529,612	$	(81	)
Mortgage-backed and collateralized
mortgage obligations - residential		2,538,858		(17,732	)		294,551		(8,646	)		2,833,409		(26,378	)
	$	3,068,470	$	(17,813	)	$	294,551	$	(8,646	)	$	3,363,021	$	(26,459	)

	Less than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
December 31, 2011	Value		Losses			Value		Losses			Value		Losses
US Government and federal agency	$	2,060,693	$	(7,811	)	$	0	$	0		$	2,060,693	$	(7,811	)
Mortgage-backed and collateralized
mortgage obligations - residential		817,615		(4,240	)		1,215,921		(6,027	)		2,033,536		(10,267	)
	$	2,878,308	$	(12,051	)	$	1,215,921	$	(6,027	)	$	4,094,229	$	(18,078	)

No securities were sold in the three months ended September 30, 2012.  There was one security sold in the first nine months of 2012.  Management chose to remove the security from the portfolio because it no longer complied with the Bank’s internal investment policy.  Proceeds from the sale were $257,997 resulting in a realized gain of $2,856.  Proceeds from sales were $820,285 for the nine months and three months ended September 30, 2011 with a gain of $3,288 realized. There were no gross losses realized on the sales during 2012 or 2011.

Other-Than-Temporary-Impairment

Management evaluates securities for OTTI at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI will be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If

- 10 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2.  SECURITIES AVAILABLE FOR SALE (Continued):

an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI will be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

At September 30, 2012, six debt securities had unrealized losses with aggregate depreciation of 0.78% from the amortized cost basis. Five of the six securities are issued by government agencies and one is issued by a government-sponsored agency. It is likely that all six debt securities will be retained given the fact that they are pledged to various public funds. The reported decline in value is not material and is deemed to be market driven. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at September 30, 2012.

3. LOANS

Outstanding loan balances by portfolio segment and class were as follows:

	September 30, 2012			December 31, 2011
Commercial	$	39,563,877		$	50,062,289
Commercial Real Estate:
General		49,555,123			59,985,723
Construction		5,841,732			6,425,041
Consumer:
Lines of credit		9,822,404			13,376,689
Other		2,086,026			2,370,625
Credit card		505,688			527,858
Residential		17,907,033			16,942,989
		125,281,883			149,691,214
Less:  Allowance for loan losses		(3,603,407	)		(5,299,454	)
Net deferred loan fees		(47,252	)		(32,283	)
Loans, net	$	121,631,224		$	144,359,477

- 11 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS

The following tables present the activity in the allowance for loan losses for the three month periods ending September 30, 2012 and 2011 by portfolio segment:

				Commercial
Three Months Ended September 30, 2012	Commercial			Real Estate			Consumer			Residential			Unallocated		Total
Allowance for loan losses:
Beginning balance	$	1,356,903		$	2,251,981		$	442,467		$	193,706		$	76,240	$	4,321,297
Charge-offs		(656,201	)		(2,299	)		(79,767	)		0			0		(738,267	)
Recoveries		10,296			8,204			1,877			0			0		20,377
Provision for loan losses		(98,273	)		(100,367	)		2,191			(39,529	)		235,978		0
Ending balance	$	612,725		$	2,157,519		$	366,768		$	154,177		$	312,218	$	3,603,407

			Commercial
Three Months Ended September 30, 2011	Commercial		Real Estate			Consumer			Residential			Total
Allowance for loan losses:
Beginning balance	$	1,487,362	$	2,715,810		$	492,977		$	239,485		$	4,935,634
Charge-offs		0		(377,914	)		(14,364	)		0			(392,278	)
Recoveries		22,612		32,345			14,176			0			69,133
Provision for loan losses		95,374		208,574			50,237			(9,493	)		344,692
Ending balance	$	1,605,348	$	2,578,815		$	543,026		$	229,992		$	4,957,181

- 12 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

The following tables present the activity in the allowance for loan losses for the nine month periods ending September 30, 2012 and 2011 by portfolio segment:

				Commercial
Nine Months Ended September 30, 2012	Commercial			Real Estate			Consumer			Residential			Unallocated		Total
Allowance for loan losses:
Beginning balance	$	1,309,632		$	3,386,433		$	410,001		$	193,388		$	0	$	5,299,454
Charge-offs		(869,270	)		(859,504	)		(111,248	)		(11,392	)		0		(1,851,414	)
Recoveries		36,844			21,727			21,761			0			0		80,332
Provision for loan losses		135,519			(391,137	)		46,254			(27,819	)		312,218		75,035
Ending balance	$	612,725		$	2,157,519		$	366,768		$	154,177		$	312,218	$	3,603,407

				Commercial
Nine Months Ended September 30, 2011	Commercial			Real Estate			Consumer			Residential			Total
Allowance for loan losses:
Beginning balance	$	1,218,865		$	2,896,176		$	546,603		$	130,263		$	4,791,907
Charge-offs		(296,963	)		(1,052,238	)		(150,026	)		(32,664	)		(1,531,891	)
Recoveries		58,392			49,486			42,169			0			150,047
Provision for loan losses		625,054			685,391			104,280			132,393			1,547,118
Ending balance	$	1,605,348		$	2,578,815		$	543,026		$	229,992		$	4,957,181

4.      

- 13 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.  ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as of September 30, 2012 and December 31, 2011:

			Commercial
September 30, 2012	Commercial		Real Estate		Consumer		Residential		Unallocated		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	143,258	$	1,384,517	$	117,672	$	74,214	$	0	$	1,719,661
Collectively evaluated for impairment		469,467		773,002		249,096		79,963		0		1,571,528
Unallocated		0		0		0		0		312,218		312,218
Total ending allowance balance	$	612,725	$	2,157,519	$	366,768	$	154,177	$	312,218	$	3,603,407
Loans:
Individually evaluated for impairment	$	3,557,244	$	8,173,209	$	332,532	$	704,346	$	0	$	12,767,331
Collectively evaluated for impairment		36,156,683		47,633,426		12,110,116		17,076,606		0		112,976,831
Total ending loans balance	$	39,713,927	$	55,806,635	$	12,442,648	$	17,780,952	$	0	$	125,744,162

			Commercial
December 31, 2011	Commercial		Real Estate		Consumer		Residential		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	466,001	$	2,312,396	$	109,309	$	103,393	$	2,991,099
Collectively evaluated for impairment		843,631		1,074,037		300,692		89,995		2,308,355
Total ending allowance balance	$	1,309,632	$	3,386,433	$	410,001	$	193,388	$	5,299,454
Loans:
Individually evaluated for impairment	$	3,930,572	$	11,063,154	$	274,700	$	595,598	$	15,864,024
Collectively evaluated for impairment		46,310,136		55,826,461		16,025,489		16,429,725		134,591,811
Total ending loans balance	$	50,240,708	$	66,889,615	$	16,300,189	$	17,025,323	$	150,455,835

- 14 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.  ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

The following tables present loans individually evaluated for impairment by class of loans as of September 30, 2012 and December 31, 2011.  For purposes of this disclosure, the Company reports unpaid principal balance net of partial charge-offs.

							Three Months		Three Months		Three Months		Nine Months		Nine Months		Nine Months
			Unpaid				Average		Interest		Cash Basis		Average		Interest		Cash Basis
	Recorded		Principal		Related		Recorded		Income		Interest		Recorded		Income		Interest
September 30, 2012	Investment		Balance		Allowance		Investment		Recognized		Recognized		Investment		Recognized		Recognized
With no related allowance recorded:
Commercial	$	2,420,379	$	2,418,966	$	0	$	2,374,733	$	13,665	$	13,665	$	2,496,173	$	40,811	$	40,696
Commercial Real Estate:
General		3,358,403		3,350,426		0		3,328,040		27,030		18,288		2,665,005		39,906		31,214
Construction		0		0		0		61,223		0		0		223,032		0		0
Consumer:
Lines of credit		40,138		40,069		0		41,072		1,966		995		47,143		8,752		4,814
Other		6,050		6,050		0		15,557		71		0		18,796		106		0
Credit card		0		0		0		0		0		0		0		0		0
Residential		323,697		323,697		0		358,875		0		0		285,696		0		0
Subtotal	$	6,148,667	$	6,139,208	$	0	$	6,179,500	$	42,732	$	32,948	$	5,735,845	$	89,575	$	76,724
With an allowance recorded:
Commercial	$	1,136,865	$	1,135,571	$	143,258	$	1,186,175	$	9,981	$	9,276	$	1,595,863	$	30,009	$	26,306
Commercial Real Estate:
General		2,854,339		2,855,279		284,485		2,922,193		33,091		32,866		3,448,840		111,506		80,952
Construction		1,960,467		1,960,467		1,100,032		1,960,467		0		0		1,988,734		0		0
Consumer:
Lines of credit		160,009		159,658		64,921		162,470		1,054		871		187,926		2,777		2,594
Other		125,765		125,605		52,181		119,951		611		484		113,378		1,572		1,447
Credit card		570		570		570		3,248		0		0		1,317		0		0
Residential		380,649		380,026		74,214		440,504		3,313		3,129		500,164		9,658		9,253
Subtotal	$	6,618,664	$	6,617,176	$	1,719,661	$	6,795,008	$	48,050	$	46,626	$	7,836,222	$	155,522	$	120,552
Total	$	12,767,331	$	12,756,384	$	1,719,661	$	12,974,508	$	90,782	$	79,574	$	13,572,067	$	245,097	$	197,276

- 15 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.  ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

							Twelve Months		Twelve Months		Twelve Months
			Unpaid				Average		Interest		Cash Basis
	Recorded		Principal		Related		Recorded		Income		Interest
December 31, 2011	Investment		Balance		Allowance		Investment		Recognized		Recognized
With no related allowance recorded:
Commercial	$	2,591,467	$	2,589,356	$	0	$	3,511,753	$	55,237	$	55,237
Commercial Real Estate:
General		4,388,271		4,377,406		0		3,265,902		123,083		107,620
Construction		227,842		227,842		0		511,659		0		0
Consumer:
Lines of credit		91,397		91,327		0		72,432		616		616
Other		0		0		0		6,012		0		0
Credit card		0		0		0		0		0		0
Residential		186,207		186,723		0		314,265		0		0
Subtotal	$	7,485,184	$	7,472,654	$	0	$	7,682,023	$	178,936	$	163,473
With an allowance recorded:
Commercial	$	1,339,105	$	1,337,955	$	466,001	$	959,371	$	30,124	$	29,623
Commercial Real Estate:
General		4,171,379		4,135,809		1,024,846		2,865,844		51,694		30,049
Construction		2,275,662		2,275,337		1,287,550		2,069,800		2,373		2,202
Consumer:
Lines of credit		63,854		63,675		16,128		145,132		11,143		3,682
Other		119,449		119,275		93,181		74,854		1,955		1,650
Credit card		0		0		0		1,006		0		0
Residential		409,391		408,244		103,393		699,853		22,948		18,135
Subtotal	$	8,378,840	$	8,340,295	$	2,991,099	$	6,815,860	$	120,237	$	85,341
Total	$	15,864,024	$	15,812,949	$	2,991,099	$	14,497,883	$	299,173	$	248,814

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.  However, non-accrual loans and loans past due 90 days still on accrual are all individually classified impaired loans.

- 16 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

The following tables present the aging of the recorded investment in past due and non accrual loans by class of loans as of September 30, 2012:

					Greater Than 90		Total Accruing				Total Recorded
	30-59 Days Past		60-89 Days Past		Days Past		Past Due		Current		Investment of
Accruing Loans	Due		Due		Due		Loans		Accruing Loans		Accruing Loans
Commercial	$	0	$	21,372	$	0	$	21,372	$	38,964,056	$	38,985,428
Commercial Real Estate:
General		0		0		0		0		48,142,071		48,142,071
Construction		0		0		0		0		4,011,383		4,011,383
Consumer:
Lines of credit		0		10,005		0		10,005		9,765,379		9,775,384
Other		0		0		0		0		2,051,825		2,051,825
Credit card		0		595		0		595		505,093		505,688
Residential		0		6,428		0		6,428		17,467,393		17,473,821
Total	$	0	$	38,400	$	0	$	38,400	$	120,907,200	$	120,945,600

					Greater Than 90		Total		Current		Total Non Accrual
	30-59 Days Past		60-89 Days Past		Days Past		Non Accrual		Non Accrual		Recorded
Non Accrual Loans	Due		Due		Due		Past Due Loans		Loans		Investment
Commercial	$	0	$	0	$	592,433	$	592,433	$	136,066	$	728,499
Commercial Real Estate:
General		156,895		96,127		144,308		397,330		1,355,756		1,753,086
Construction		0		0		0		0		1,900,095		1,900,095
Consumer:
Lines of credit		0		0		0		0		103,701		103,701
Other		0		6,050		0		6,050		0		6,050
Credit card		0		0		0		0		0		0
Residential		0		0		195,649		195,649		111,482		307,131
Total	$	156,895	$	102,177	$	932,390	$	1,191,462	$	3,607,100	$	4,798,562

- 17 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.  ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

The following tables present the aging of the recorded investment in past due and non accrual loans by class of loans as of December 31, 2011:

					Greater Than 90		Total Accruing				Total Recorded
	30-59 Days Past		60-89 Days Past		Days Past		Past Due		Current		Investment of
Accruing Loans	Due		Due		Due		Loans		Accruing Loans		Accruing Loans
Commercial	$	576,736	$	48,273	$	0	$	625,009	$	48,278,897	$	48,903,906
Commercial Real Estate:
General		197,488		243,075		0		440,563		57,422,942		57,863,505
Construction		0		0		0		0		4,063,776		4,063,776
Consumer:
Lines of credit		11,052		102,760		21,002		134,814		13,194,317		13,329,131
Other		8,817		0		0		8,817		2,306,281		2,315,098
Credit card		0		0		5,899		5,899		521,959		527,858
Residential		80,952		0		0		80,952		16,772,293		16,853,245
Total	$	875,045	$	394,108	$	26,901	$	1,296,054	$	142,560,465	$	143,856,519

					Greater Than 90		Total		Current		Total Non Accrual
	30-59 Days Past		60-89 Days Past		Days Past		Non Accrual		Non Accrual		Recorded
Non Accrual Loans	Due		Due		Due		Past Due Loans		Loans		Investment
Commercial	$	0	$	2,478	$	1,172,890	$	1,175,368	$	161,434	$	1,336,802
Commercial Real Estate:
General		0		0		869,398		869,398		1,673,895		2,543,293
Construction		0		0		406,090		406,090		2,012,951		2,419,041
Consumer:
Lines of credit		4,826		66,587		48,230		119,643		0		119,643
Other		0		0		8,459		8,459		0		8,459
Credit card		0		0		0		0		0		0
Residential		0		0		0		0		172,078		172,078
Total	$	4,826	$	69,065	$	2,505,067	$	2,578,958	$	4,020,358	$	6,599,316

- 18 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

Troubled Debt Restructurings:

The Company has allocated $1,651,715 of specific reserves on $10,672,624 of loans to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2012 and $1,499,705 on $9,036,794 as of December 31, 2011. At September 30, 2012, the Company did not have any additional performing loans outstanding to those customers. As of December 31, 2011, there was $222,700 committed to one customer.

During the nine month period ending September 30, 2012, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a stated rate of interest lower than the current market rate for new debt with similar risk; interest only payments on an amortizing note; a reduced payment amount which does not fully cover the interest; or a permanent reduction of the recorded investment in the loan.

Modifications involving a stated interest rate of the loan below the current market rate were for periods ranging from 11 months to 5 years. Modifications involving a reduced payment amount were for periods ranging from 5 months to 4 years. Two modifications involved a permanent reduction of the recorded investment in the loan.

There were no loans modified as troubled debt restructurings during the three month period ending September 30, 2012.

In the three month period ended September 30, 2012, there were no charge-offs as part of a troubled debt restructuring arrangement.

- 19 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

The following table presents loans by class modified as troubled debt restructurings that occurred during the nine month period ending September 30, 2012:

			Pre-Modification		Post-Modification
			Outstanding Recorded		Outstanding Recorded
Nine Months Ended September 30, 2012	Number of Loans		Investment		Investment
Troubled Debt Restructurings:
Commercial		1	$	11,880	$	11,880
Commercial Real Estate:
General		5		3,446,269		2,808,146
Consumer:
Lines of credit		2		126,860		126,860
Residential		1		62,085		62,085
Total		9	$	3,647,094	$	3,008,971

In the nine month period ended September 30, 2012, there were $638,000 of charge-offs as part of a troubled debt restructuring arrangement and an additional $49,000 of specific reserves were established on these troubled debt restructurings.

Generally, a modified loan is considered to be in payment default when the borrower is not performing according to the renegotiated terms.

For the three and nine month periods ending September 30, 2012, there were no troubled debt restructurings that experienced a payment default within twelve months following the modification.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed utilizing the Company’s internal underwriting policy.

- 20 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.  ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

Credit Quality Indicators:

The Bank utilizes a numeric grading system for commercial and commercial real estate loans to indicate the strength of the credit. At origination, grades are assigned to each commercial and commercial real estate loan by assessing information about the specific borrower’s situation including cash flow analysis and the estimated collateral values. The loan grade is reassessed at each renewal or amendment but any credit may receive a review based on lender identification of changes in the situation or behavior of the borrower. All commercial and commercial real estate loans exceeding $500,000 are formally reviewed at least annually. Once a loan is graded a 5M or greater number, and is over $100,000, the loan grade will be reanalyzed once per quarter to assess the borrowers compliance with the Bank’s documented action plan. In addition to these methods for assigning loan grades, changes may occur through the external loan review or regulatory exam process. The loan grades are as follows:

1.   Exceptional. Loans with an exceptional credit rating.

2.   Quality. Loans with excellent sources of repayment that conform, in all respects, to Bank policy and regulatory requirements. These are loans for which little repayment risk has been identified.

3.   Above Average. Loans with above average sources of repayment and minimal identified credit or collateral exceptions and minimal repayment risk.

4.   Average. Loans with average sources of repayment that materially conform to Bank policy and regulatory requirements. Repayment risk is considered average.

5.   Acceptable. Loans with acceptable sources of repayment and risk.

  5M.    Monitor. Loans considered to be below average quality. The loans are often fundamentally sound but require more frequent management review because of an adverse financial event. Risk of non payment is elevated.

6.   Special Mention. Loans that have potential weaknesses and deserve close attention. If uncorrected, further deterioration is likely. Risk of non payment is above average.

7.   Substandard. Loans that are inadequately protected by the borrower’s capacity to pay or the collateral pledged. Risk of non payment is high.

8.   Doubtful. Loans in this grade have identified weaknesses that make full repayment highly questionable and improbable.

When a loan is downgraded to a nine, it is considered a loss and is charged-off.

- 21 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

As of September 30, 2012 and December 31, 2011, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

					Commercial Real Estate				Commercial Real Estate
	Commercial				General				Construction
	September 30,		December 31,		September 30,		December 31,		September 30,		December 31,
	2012		2011		2012		2011		2012		2011
1	$	0	$	0	$	0	$	0	$	0	$	0
2		153,086		253,956		0		0		0		0
3		2,680,865		4,947,905		2,299,403		3,141,880		0		0
4		13,796,531		13,552,704		14,361,064		19,274,469		445,753		271,335
5		14,835,928		21,119,918		19,878,556		21,250,749		2,009,376		2,347,947
5M		4,353,544		3,910,143		6,023,053		5,452,332		1,398,284		1,360,030
6		345,345		1,838,505		5,297,777		7,562,147		0		0
7		3,010,614		3,567,564		1,693,691		2,293,571		97,598		39,330
8		538,014		1,050,013		341,613		1,431,650		1,960,467		2,464,175
Total	$	39,713,927	$	50,240,708	$	49,895,157	$	60,406,798	$	5,911,478	$	6,482,817

The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses.  For residential and consumer loan classes, the Company evaluates credit quality based on the aging status of the loan, which was previously presented and by payment activity.  The following tables present the recorded investment in residential and consumer loans based on payment activity as of September 30, 2012 and December 31, 2011:

	Residential
	September 30,		December 31,
	2012		2011
Performing	$	17,076,606	$	16,429,725
Impaired		704,346		595,598
Total	$	17,780,952	$	17,025,323

	Consumer – Lines of credit				Consumer – Other				Consumer – Credit card
	September 30,		December 31,		September 30,		December 31,		September 30,		December 31,
	2012		2011		2012		2011		2012		2011
Performing	$	9,678,938	$	13,293,523	$	1,926,060	$	2,204,108	$	505,118	$	527,858
Impaired		200,147		155,251		131,815		119,449		570		0
Total	$	9,879,085	$	13,448,774	$	2,057,875	$	2,323,557	$	505,688	$	527,858

- 22 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

5.  FORECLOSED ASSETS

Foreclosed asset activity for the nine months ended was as follows:

	September 30,			September 30,
	2012			2011
Beginning of year	$	3,276,838		$	3,382,594
Additions		1,243,347			876,597
Reductions from sales		(1,249,206	)		(515,305	)
Direct write-downs		(277,448	)		(1,038,725	)
End of period	$	2,993,531		$	2,705,161
Expenses related to foreclosed assets include:
Operating expenses, net of rental income	$	199,278		$	102,292

6.  PREMISES AND EQUIPMENT

Period end premises and equipment were as follows:

	September 30,		December 31,
	2012		2011
Land & land improvements	$	4,700,464	$	5,466,281
Buildings & building improvements		6,132,163		6,132,163
Furniture, fixtures and equipment		3,681,462		3,679,037
Construction in process		113,980		0
		14,628,069		15,277,481
Less:  accumulated depreciation		5,158,971		4,872,616
	$	9,469,098	$	10,404,865

During the second quarter of 2012, the Company sold land with a carrying value of $790,135 resulting in a gain on sale of $208,389.

- 23 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7.  DEPOSITS

The components of the outstanding deposit balances at September 30, 2012 and December 31, 2011 were as follows:

	September 30,		December 31,
	2012		2011
Non-interest-bearing DDA	$	45,158,043	$	33,281,198
Interest-bearing DDA		23,290,924		19,432,618
Money market		18,870,059		18,468,540
Savings		9,375,425		8,477,893
Time, under $100,000		83,351,558		95,211,768
Time, over $100,000		9,248,123		16,673,219
Total Deposits	$	189,294,132	$	191,545,236

There were no brokered deposits at September 30, 2012 and $3,462,000 at December 31, 2011. Since the Bank was not categorized as “well capitalized” at September 30, 2012 and is under a Consent Order, a regulatory waiver is required to accept, renew or rollover brokered deposits. The Bank has not issued brokered deposits since January of 2010.

8. SHORT-TERM BORROWINGS

The Company’s short-term borrowings consist of repurchase agreements and less frequently borrowings from the FRB Discount Window. There have been no borrowings from the FRB Discount Window since January 2010. The September 30, 2012 and December 31, 2011 short-term borrowing information was as follows:

	Repurchase
	Agreements
Outstanding at September 30, 2012	$	8,593,208
Average interest rate at period end		0.72	%
Average balance during period		9,606,429
Average interest rate during period		0.76	%
Maximum month end balance during period		12,037,087
Outstanding at December 31, 2011	$	7,814,745
Average interest rate at year-end		0.71	%
Average balance during year		9,626,125
Average interest rate during year		0.76	%
Maximum month end balance during year		11,986,254

- 24 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. FEDERAL HOME LOAN BANK BORROWINGS

The Bank is a member of the Federal Home Loan Bank of Indianapolis.  Based on its current Federal Home Loan Bank Stock holdings and collateral, the Bank has the capacity to borrow $2,780,869. Each borrowing requires a direct pledge of securities or loans or both. To support potential borrowings with the Federal Home Loan Bank, the Bank had residential loans with a fair market value of $3,476,086 pledged at September 30, 2012. The Bank had no outstanding borrowings with the Federal Home Loan Bank at either September 30, 2012 or December 31, 2011.

10. SUBORDINATED DEBENTURES

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 2.41% at September 30, 2012 and 2.63% at December 31, 2011. The stated maturity is December 30, 2034. The trust preferred securities are redeemable at par on any interest payment date and are, in effect, guaranteed by the Company. Interest on the subordinated debentures are payable quarterly on March 30th, June 30th, September 30th and December 30th. The Company is not considered the primary beneficiary of the Trust (variable interest entity), therefore the Trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability, and the interest expense is recorded on the Company’s consolidated statement of income.

The terms of the subordinated debentures, the trust preferred securities and the agreements under which they were issued, give the Company the right, from time to time, to defer payment of interest for up to 20 consecutive quarters, unless certain specified events of default have occurred and are continuing.  The deferral of interest payments on the subordinated debentures results in the deferral of distributions on the trust preferred securities. In May 2010, the Company exercised its option to defer regularly scheduled quarterly interest payments beginning with the quarterly interest payment that was scheduled to be paid on June 30, 2010. The Company’s deferral of interest does not constitute an event of default.

During the deferral period, interest will continue to accrue on the subordinated debentures.  Also, the deferred interest will accrue interest.  At the expiration of the deferral period, all accrued and unpaid interest will be due and payable and a corresponding amount of distributions will be payable on the trust preferred securities.

The indenture under which the subordinated debentures were issued prohibits certain actions by the Company during the deferral period.  Among other things, and subject to certain exceptions, during the deferral period, the Company is prohibited from declaring or paying any dividends or distributions on, or redeeming, purchasing, acquiring or making any liquidation payment with respect to, any shares of its capital stock.  Although the Company has not determined the duration of the deferral period, as of December 16, 2010, under the FRB Written Agreement, the Company is prohibited from making any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior FRB approval. At September 30, 2012, the accrued interest payable on the subordinated debentures was $295,555.

- 25 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11.  NOTES PAYABLE

On January 3, 2011, the Company’s $5,000,000 term loan with Fifth Third Bank (“Fifth Third”) matured. The loan is in default, and the Company does not have the resources to pay the outstanding principal and accrued interest and does not expect to have it in the near future. Under the terms of the note, Fifth Third has the right to foreclose on the Bank’s stock which collateralizes the loan. As of September 30, 2012, Fifth Third has not taken any foreclosure action or communicated intent to do so. The Company continues to accrue interest at the rate of the term loan at maturity and after which is 6.00%, 275 basis points above Fifth Third’s prime rate. On September 30, 2012, there was $686,000 of unpaid interest compared to $458,000 at December 31, 2011.
 

12.  COMMITMENTS AND OFF-BALANCE SHEET RISK

Some financial instruments are used to meet financing needs and to reduce exposure to interest rate changes.  These financial instruments include commitments to extend credit and standby letters of credit.  These involve, to varying degrees, credit and interest-rate risk in excess of the amount reported in the financial statements. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment, and generally have fixed expiration dates.  Standby letters of credit are conditional commitments to guarantee a customer’s performance to another party.  Exposure to credit loss, if the customer does not perform, is represented by the contractual amount for commitments to extend credit and standby letters of credit.  Collateral or other security is normally obtained for these financial instruments prior to their use and many of the commitments are expected to expire without being used.

A summary of the notional and contractual amounts of outstanding financing instruments with off-balance-sheet risk as of September 30, 2012 and December 31, 2011 follows:

	September 30, 2012		December 31, 2011
Unused lines of credit and letters of credit	$	24,457,739	$	22,611,655
Commitments to make loans		862,850		0

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 credit expire without being used, the above amounts related to those categories do not necessarily represent future cash disbursements.

13.  FAIR VALUE MEASUREMENTS

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. A fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

- 26 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13. FAIR VALUE MEASUREMENTS (Continued)

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate fair value:

Securities:  The fair values of securities are obtained from a third party who utilizes quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing (Level 2 inputs), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.

Servicing Rights: The fair value of SBA servicing rights is obtained from a third party using assumptions provided by the Company. The individual servicing rights are valued individually taking into consideration the original term to maturity, the current age of the loan and the remaining term to maturity. Their valuation methodology utilized for the servicing rights begins with projecting future cash flows for each servicing asset, based on its unique characteristics and market-based assumptions for prepayment speeds. The present value of the future cash flows are then calculated utilizing a market-based discount rate assumption. These inputs are generally observable in the marketplace resulting in a Level 2 classification.

Impaired Loans:  The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals or internal evaluations. Management may add discounts to third party appraisals. The appraisals are generally obtained annually and are performed by qualified licensed appraisers approved by the Board of Directors.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. The comparable sales approach evaluates the sales price of similar properties in the same market area.  This approach is inherently subjective due to the wide range of comparable sale dates. The income approach considers net operating income generated by the property and the investor’s required return.  This approach utilizes various inputs including lease rates and cap rates which are subject to judgment. Such adjustments can be significant and result in a Level 3 classification of the inputs for determining fair value.

Foreclosed Assets:  Commercial and residential real estate properties classified as foreclosed assets are measured at fair value, less costs to sell. Fair values are generally based on recent real estate appraisals or internal evaluations. Management may add discounts to third party appraisals. The appraisals are generally obtained annually and are performed by qualified licensed appraisers approved by the Board of Directors. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.The comparable sales approach evaluates the sales price of similar properties in the same market area.  This approach is inherently subjective due to the wide range of comparable sale dates. The income approach considers net operating income generated by the property and the investor’s required return.  This approach utilizes various inputs including lease rates and cap rates which are subject to judgment. Adjustments of the carrying amount utilizing this process result in a Level 3 classification.

- 27 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13. FAIR VALUE MEASUREMENTS (Continued)

Assets measured at fair value on a recurring basis are summarized below as of the periods ended September 30, 2012 and December 31, 2011:

			Fair Value Measurements Using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
September 30, 2012	Total		(Level 1)		(Level 2)		(Level 3)
Available for sale securities:
US Treasury	$	4,608,047	$	4,608,047	$	0	$	0
US Government and
federal agency		18,811,536		0		18,811,536		0
Municipals		2,350,674		0		2,350,674		0
Mortgage-backed and
collateralized mortgage
obligations– residential		12,438,281		0		12,438,281		0
Total	$	38,208,538	$	4,608,047	$	33,600,491	$	0
Servicing assets	$	42,069	$	0	$	42,069	$	0
December 31, 2011
Available for sale securities:
US Treasury	$	4,067,656	$	4,067,656	$	0	$	0
US Government and
federal agency		15,572,588		0		15,572,588		0
Municipals		2,891,420		0		2,891,420		0
Mortgage-backed and
collateralized mortgage
obligations– residential		12,040,439		0		12,040,439		0
Total	$	34,572,103	$	4,067,656	$	30,504,447	$	0
Servicing assets	$	76,276	$	0	$	76,276	$	0

There were no transfers between levels during the first nine months of 2012 or the three month periods ended September 30, 2012 or 2011.  During the first quarter of 2011, there was a transfer of two federal agency securities with a fair value of $991,568 at March 31, 2011 from Level 1 to Level 2.

- 28 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13.  FAIR VALUE MEASUREMENTS (Continued)

Assets measured at fair value on a non-recurring basis are summarized below as of the periods ended September 30, 2012 and December 31, 2011.  Impaired loans and foreclosed assets are included if the fair value of such assets was revised during the quarterly period then ended.

			Significant
			Unobservable Inputs
	Total		(Level 3)
September 30, 2012
Impaired loans:
Commercial	$	267,781	$	267,781
Commercial Real Estate:
General		165,511		165,511
Construction		0		0
Consumer:
Lines of credit		286		286
Other		68,438		68,438
Residential		257,998		257,998
Total	$	760,014	$	760,014
Foreclosed assets:
Commercial Real Estate:
General	$	574,475	$	574,475
Construction		105,954		105,954
Total	$	680,429	$	680,429
December 31, 2011
Impaired loans:
Commercial	$	19,686	$	19,686
Commercial Real Estate:
General		3,871,595		3,871,595
Construction		160,276		160,276
Consumer:
Lines of credit		48,269		48,269
Other		0		0
Residential		198,244		198,244
Total	$	4,298,070	$	4,298,070
Foreclosed assets:
Commercial Real Estate:
General	$	570,069	$	570,069
Construction		6,160		6,160
Residential		204,668		204,668
Total	$	780,897	$	780,897

As discussed previously, the Bank generally utilizes real estate appraisals or internal evaluations for the valuation of its impaired loans and foreclosed assets.  These valuations use either a comparable sales or income approach.  Adjustments are routinely made in the appraisal process by the appraisers to account for differences between the comparable sales and income data available. These adjustments can vary from 0 to 40% depending on the property type as well as various sales and property characteristics including but not limited to: date of sale, size and condition of facility, quality of construction and proximity to the subject property.

- 29 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13. FAIR VALUE MEASUREMENTS (Continued)

Further unobservable inputs used in estimating fair value are additional discounts to the appraised value to consider: 1) selling costs where discounts can range from 2 to 15% and 2) the age of the appraisal with discounts ranging from 10 to 30%.

The following table presents information as of September 30, 2012 about significant unobservable inputs related to the Bank’s individually material Level 3 financial assets, by class, measured on a nonrecurring basis:

			Valuation	Significant Unobservable	Range			Weighted
	Fair Value		Technique (s)	Inputs	of Inputs			Average
September 30, 2012
Impaired loans:				Adjustments for differences between
Residential	$	212,812	Sales comparison approach	the comparable sales		0	%		0	%
Total	$	212,812
Foreclosed assets:
Commercial Real Estate:				Adjustments for differences between
General	$	404,919	Sales comparison approach	the comparable sales		10.0	%		10.0	%
Total	$	404,919

The following two paragraphs describe the impairment charges recognized during the period:

The method used to determine the valuation of impaired loans depends on the anticipated source of repayment. Most of the Bank’s impaired loans are collateral dependent; only two impairments are measured using the cash flow method. Collateral dependent impaired loans are measured using the fair value of the collateral. At September 30, 2012, such impaired loans had a recorded investment of $5,537,693, with a valuation allowance of $1,605,902 compared to impaired loans with a recorded investment of $7,528,841 and a valuation allowance of $2,902,547 at December 31, 2011. The fair value of the collateral on the collateral dependent loans was determined using independent appraisals or internal evaluations and was adjusted for anticipated disposition costs. Increases to specific allocations on impaired, collateral dependent loans were $636,000 for the first nine months of 2012. However, in total, the impact to the provision for loan losses from impaired, collateral dependent loans was $(1,297,000) for the nine month period ended September 30, 2012.

At September 30, 2012 and December 31, 2011, foreclosed assets carried a fair value of $2,993,531 and $3,276,838 respectively. During the nine month period ended September 30, 2012, twenty-two properties included in this total were written down by $277,448. There were also eleven properties totaling $1,243,347 (at fair value) added to other real estate owned during the first nine months of 2012. The fair value of other real estate owned was determined primarily using independent appraisals or internal evaluations and was adjusted for anticipated disposition costs.

- 30 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13. FAIR VALUE MEASUREMENTS (Continued)

The carrying amounts and estimated fair values of financial instruments not previously presented above are as follows:

			Fair Value Measurements								December 31,
			at September 30, 2012 Using								2011
	Carrying										Carrying		Fair
	Amount		Level 1		Level 2		Level 3		Total		Amount		Value
	(in thousands)
Financial assets
Cash and cash equivalents	$	27,436	$	27,436	$	0	$	0	$	27,436	$	8,920	$	8,920
Loans held for sale		6,036		0		6,323		0		6,323		5,535		5,940
Loans, net (including impaired)		121,631		0		0		113,823		113,823		144,359		139,176
FHLB stock		451		N/A		N/A		N/A		N/A		451		N/A
Accrued interest receivable		651		19		174		458		651		746		746
Financial liabilities
Deposits		189,294		96,187		93,431		0		189,618		191,545		193,775
Federal funds purchased and
repurchase agreements		8,593		0		8,593		0		8,593		7,815		7,815
Subordinated debentures		4,500		0		0		1,125		1,125		4,500		1,125
Notes payable		5,000		0		0		900		900		5,000		500
Accrued interest payable		1,053		5		67		74		146		738		130

The methods and assumptions, not previously presented above, used to estimate fair values are described as follows:

(a) Cash and cash equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.

(b) FHLB stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

(c) Loans

Fair values of loans, excluding loans held for sale, are estimated as follows:  For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification.  Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

- 31 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13.  FAIR VALUE MEASUREMENTS (Continued)

(d) Deposits

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(e) Federal funds purchased and repurchase agreements

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.

(f) Subordinated debentures and Notes payable

The fair values of the Company’s subordinated debentures and notes payable are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements and consideration of the Company’s liquidity, resulting in a Level 3 classification.

(g) Accrued interest receivable/payable
 

The carrying amounts of accrued interest approximate fair value resulting in a Level 1, 2 or 3 classification, depending on the associated asset or liability.

(h) Off-balance sheet instruments
 

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.

14. INCOME TAXES

Accounting guidance related to income taxes requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard.  In making such judgments, we consider both positive and negative evidence and analyze changes in near-term market conditions as well as other factors which may impact future operating results. Significant weight is given to evidence that can be objectively verified.  The previous losses dating back to 2008 due to the distressed operating environment in Michigan have significantly restricted our ability under the accounting rules to rely on projections of future taxable income to support the recovery of our deferred tax assets. Consequently, we determined it necessary to carry a valuation allowance against our entire net deferred tax asset.  The valuation allowance against our deferred tax assets may be reversed to income in future periods to the extent that the related deferred income tax assets are realized or the valuation allowance is otherwise no longer required.  We will continue to monitor our deferred tax assets quarterly for changes affecting their realizability.

- 32 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15.  REGULATORY MATTERS

Banks are subject to regulatory capital requirements administered by the federal banking agencies.  Since the Company is a one bank holding company with consolidated assets less than $500 million, regulatory minimum capital ratios are applied only to the Bank.  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 a bank is not well capitalized, regulatory approval is required to accept brokered deposits.  Subject to limited exceptions, a bank may not make a capital distribution if, after making the distribution, it would be undercapitalized.  If a bank is undercapitalized, it is subject to being closely monitored by its principal federal regulator, its asset growth and expansion are restricted, acquisitions, new activities, new branches, payment of dividends or management fees are prohibited and plans for capital restoration are required. In addition, further specific types of restrictions may be imposed on the bank at the discretion of the federal regulator. The Bank was in the undercapitalized category at both September 30, 2012 and December 31, 2011.

- 33 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15. REGULATORY MATTERS (Continued)

Actual capital amounts and ratios for the Bank and required capital amounts and ratios for the Bank to be adequately capitalized and to be at the level mandated by the Consent Order at September 30, 2012 and December 31, 2011 were:

						Minimum Required					Minimum Required
						For Capital					Under
	Actual					Adequacy Purposes					Consent Order
	Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2012
Total Capital (Tier 1 and
Tier 2) to risk-weighted
assets of the Bank	$	10,611,314		7.80	%	$	10,888,742		8.00	%	$	14,972,020		11.00	%
Tier 1 (Core) Capital
to risk-weighted
assets of the Bank		8,886,466		6.53			5,444,371		4.00			N/A		N/A
Tier 1 (Core) Capital
to average assets
of the Bank		8,886,466		4.25			8,372,888		4.00			17,792,388		8.50

						Minimum Required					Minimum Required
						For Capital					Under
	Actual					Adequacy Purposes					Consent Order
	Amount		Ratio			Amount		Ratio			Amount		Ratio
December 31, 2011
Total Capital (Tier 1 and
Tier 2) to risk-weighted
assets of the Bank	$	10,350,300		6.40	%	$	12,944,731		8.00	%	$	17,799,005		11.00	%
Tier 1 (Core) Capital
to risk-weighted
assets of the Bank		8,287,231		5.12			6,472,366		4.00			N/A		N/A
Tier 1 (Core) Capital
to average assets
of the Bank		8,287,231		3.79			8,756,307		4.00			18,607,152		8.50

Federal Reserve guidelines limit the amount of allowance for loan losses that can be included in Tier 2 capital. In general only 1.25% of net risk-weighted assets are allowed to be included. At September 30, 2012, only $1,724,848 was counted as Tier 2 capital and $1,878,559 was disallowed.  At December 31, 2011, $2,063,069 was counted as Tier 2 capital and $3,236,385 was disallowed.

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COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15. REGULATORY MATTERS (Continued)

The Bank’s Consent Order with the FDIC and the OFIR, its primary banking regulators, became effective on September 2, 2010. The Bank agreed to the terms of the Consent Order without admitting or denying any charge of unsafe or unsound banking practices relating to capital, asset quality, or earnings. The Consent Order imposes no fines or penalties on the Bank. The Consent Order will remain in effect and enforceable until it is modified, terminated, suspended, or set aside by the FDIC and OFIR.

The Consent Order required the Bank to implement a written profit plan, a written contingency funding plan, a written plan to reduce the Bank's reliance on brokered deposits, a comprehensive strategic plan; and to develop an analysis and assessment of the Bank's management needs.  Under the Consent Order, the Bank is required to maintain higher capital levels than requested under prompt corrective action and the Bank may not declare or pay any dividend without the prior written consent of the regulators.

Prior to the issuance of the Consent Order, the Bank's Board of Directors and management had already commenced initiatives and strategies to address a number of the requirements of the Consent Order. The Bank continues to work in cooperation with its regulators.  Our ability to fully comply with all of the requirements of the Consent Order, including maintaining specified capital levels, is not entirely within our control, and is not assured. Our ability to comply with the requirements of the Consent Order may be affected by many factors, including the availability of capital and other funds, the extent of repayment of loans by borrowers, declines in the value of collateral including real estate, the Bank's ability to realize on collateral, actions that may be taken by our lender in connection with our matured $5,000,000 term loan and actions by bank regulators. Failure to comply with provisions of the Consent Order may result in further regulatory action that could have a material adverse effect on us and our shareholders, as well as the Bank.

There were several directives related to loans contained in the Consent Order. All action plans have been submitted to the FDIC. Management continues to update the action plans and is working diligently to reduce the risk position as outlined in each action plan.
 

Under the Consent Order the Bank was required, within 90 days of September 2, 2010, to have and maintain its level of tier one capital, as a percentage of its total assets, at a minimum of 8.5%, and its level of qualifying total capital, as a percentage of risk-weighted assets, at a minimum of 11%. The Bank was not in compliance with this requirement at September 30, 2012 or either December 31, 2010 or 2011. Management continues to explore options to raise the capital required for full compliance. At September 30, 2012, a capital contribution of $8,906,000 would have been needed to meet the capital ratios specified in the Consent Order.

Under the Consent Order the Bank is restricted from declaring or paying dividends without prior written authorization of the FDIC. The Bank is in full compliance with this restriction.

As required by the Consent Order, the Bank adopted a detailed liquidity plan on November 17, 2010 which provided for intended liquidity sources to meet the Bank’s assessed liquidity needs over the time horizons of 6, 12 and 18 months.  As a condition of the Consent Order, the Bank is unable to accept brokered deposits.

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COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15. REGULATORY MATTERS (Continued)

Since the beginning of 2010, the Bank has been able to replace maturing brokered deposits with local deposits, including internet based time deposits and core deposits. Management does not believe the restriction on issuing brokered deposits imposes a significant liquidity problem for the Bank. There were no brokered deposit balances at September 30, 2012.

On August 17, 2011, the Bank was issued a Supervisory Prompt Corrective Action Directive (the “Directive”) because of its undercapitalized capital category at December 31, 2010, its failure to submit a capital restoration plan that satisfies the requirements spelled out in the FDIC Rules and Regulations, and the continued deterioration of the Bank. The Directive stipulated that the Bank be restored to an “adequately capitalized” capital category within 60 days of the issuance of the

Directive. Since the issuance of the Consent Order, the board has made many efforts to secure funding and comply with both the Consent Order and the Directive but has not been successful. As such, the Bank was not in compliance with the Directive at the end of 60 days and remains out of compliance. The board informed the FDIC in a letter dated October 14, 2011 that it was unable to comply with the Directive. There has been no further communications with the FDIC regarding the Directive. The board’s efforts to garner capital for the Bank are continuing.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 

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, and Berryfield, the Mortgage Company’s subsidiary, through September 30, 2012 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, 2012 to that at December 31, 2011. The part labeled Results of Operations discusses the three and nine month periods ending September 30, 2012 as compared to the same periods of 2011. 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-Q.

This discussion and analysis of financial condition and results of operations, and other sections of the Form 10-Q 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, Berryfield 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 or actions by bank regulators; 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 local real estate values; changes in the national and local economy; the ability of the Company to borrow money or raise additional capital to maintain or increase its or the Bank’s capital position or when desired to support future growth; action that Fifth Third may take in connection with its $5.0 million term loan to the Company, the repayment of which is now in default; lack of adequate cash by the Company to continue its business or pay its debts; failure to comply with provisions of the Consent Order, Written Agreement or Directive may result in further regulatory action that could have a material adverse effect on us and our shareholders, as well as the Bank; 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. These risks and uncertainties should be considered when evaluating forward-looking statements. Undue reliance should not be placed on such statements.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The overall economic environment remains challenging but appears to be stabilizing, both nationally and locally. Unemployment in Muskegon and Ottawa counties is declining but remains at a serious level. At September 30, 2012, unemployment was 8.0% for Muskegon County and 5.8% for Ottawa County. Additionally, property values, although low, are steadying which should lead to improved sales and construction activity. Although the current outlook is more optimistic, the effects of the extended downturn had a negative effect on the financial health of the Bank. Poor earnings stemming primarily from deteriorating asset quality eroded the Bank’s capital ratios subjecting it to additional regulatory scrutiny.

On September 2, 2010, the Bank entered into a Consent Order with the Federal Deposit Insurance Corporation (“FDIC”) and the State of Michigan’s Office of Financial and Insurance Regulation (“OFIR”), its primary regulators. The Bank agreed to the terms of the Consent Order without admitting or denying any charge of unsafe or unsound banking practices relating to capital, asset quality, or earnings. The Consent Order imposes no fines or penalties on the Bank. The Consent Order will remain in effect and enforceable until it is modified, terminated, suspended, or set aside by the FDIC and OFIR. Under the Consent Order the Bank was required, within 90 days of September 2, 2010, to have and maintain its level of Tier 1 capital, as a percentage of its total assets, at a minimum of 8.5%, and its level of qualifying total capital, as a percentage of risk-weighted assets, at a minimum of 11%. The Bank was not able to meet these requirements within the required 90-day period and remains out of compliance with the Consent Order as of September 30, 2012.

The lack of financial soundness of the Bank and the Company’s inability to serve as a source of strength for the Bank resulted in the board of directors entering into a Written Agreement with the Federal Reserve Bank of Chicago (the “FRB”), the Company’s primary regulator. The Written Agreement became effective on December 16, 2010, when it was executed by the FRB. The Written Agreement provides that: (i) the Company must take appropriate steps to fully utilize its financial and managerial resources to serve as a source of strength to the Bank; (ii) the Company may not declare or pay any dividends or take dividends or any other payment representing a reduction in capital from the Bank or make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior FRB approval; (iii) the Company may not incur, increase or guarantee any debt or purchase or redeem any shares of its stock without prior FRB approval; (iv) the Company must submit a written statement of its planned sources and uses of cash for debt service, operating expenses and other purposes to the FRB within 30 days of the Written Agreement; (v) the Company shall take all necessary actions to ensure that the Bank, the Company and all nonbank subsidiaries of both the Bank and the Company comply with sections 23A and 23B of the Federal Reserve Act and Regulation W of the Board of Governors (12 C.F.R. Part 223) in all transactions between affiliates; (vi) the Company may not appoint any new director or senior executive officer, or change the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position, without prior regulatory approval; and finally (vii) within 30 days after the end of each calendar quarter following the date of the Written Agreement, the board of directors shall submit to the FRB written progress reports detailing the form and manner of all actions taken to secure compliance with the provisions of the Written Agreement as well as current copies of the parent company only financial statements. The Company has not yet been able to meet the obligation detailed in part (i) above; as the Company currently has negative equity and limited resources with which to support the capital needs of the Bank.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Company’s main liquidity resource is its cash account balance which, as of September 30, 2012, was approximately $32,000. At this time, the Company has chosen to postpone the decision to take advantage of the Jumpstart Our Business Startups Act (the “JOBS Act”) and deregister as a public company. Management and the Board of Directors are considering many options for obtaining funding for the Company and do not believe it would be in the best interest of the Company to limit its options by deregistering. It is projected that the level of cash held at September 30, 2012 is adequate to support the Company’s overhead expenses through year-end 2012.

On January 3, 2011, the Company was not able to repay its $5 million term loan when it came due. The Company does not have the resources to pay the outstanding principal and does not expect to have it in the near future. The Company did not make the last ten contractual quarterly interest payments. The total interest due to Fifth Third at year-end 2011 was $458,000. The Company continues to accrue interest on the term loan and at September 30, 2012, the total interest due Fifth Third was $686,000. Since the Company presently does not have sufficient funds to pay off the term loan’s principal and accrued interest, Fifth Third has a right to foreclose on the Bank’s stock which collateralizes the term loan.

On August 17, 2011, the Bank was issued a Supervisory Prompt Corrective Action Directive (the “Directive”) because of its undercapitalized capital category at December 31, 2010, its failure to submit a capital restoration plan that satisfies the requirements stipulated in the FDIC Rules and Regulations, and the continued deterioration of the Bank. The Directive stipulated that the Bank be restored to an “adequately capitalized” capital category within 60 days of the issuance of the Directive. During the 60 days, the board made efforts to secure funding and comply with the Directive but was not successful. As such, the Bank was not in compliance with the Directive at the end of 60 days and remains out of compliance. The board informed the FDIC in a letter dated October 14, 2011 that it was unable to comply with the Directive. There has been no further communications with the FDIC regarding the Directive. The board’s efforts to garner capital for the Bank are expected to continue.

Failure to comply with the provisions of the Consent Order, the Written Agreement or the Directive may subject the Bank to further regulatory enforcement action.

The Company’s net losses, failure to repay its term loan at maturity, non-compliance with the higher capital ratios of the Directive and the Consent Order, and the provisions of the Written Agreement raise substantial doubt about the Company’s ability to continue as a going concern. As a result of this substantial doubt, our auditors added an explanatory paragraph to their opinion on the Company’s December 31, 2011 and 2010 consolidated financial statements expressing substantial doubt about the Company’s ability to continue as a going concern. These financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

FINANCIAL CONDITION

Total assets decreased by $930,000 to $207.7 million at September 30, 2012 from $208.6 million at December 31, 2011. Although this decrease in assets is less than 1% during the first nine months of 2012, there has been a noticeable change in the overall composition. Since year-end 2011, there has been a large decline in the loan portfolio which increased the cash held in interest bearing bank accounts.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cash and cash equivalents increased by $18.5 million to $27.4 million at September 30, 2012 from $8.9 million at December 31, 2011. Balances kept at the FRB increased $18.2 million since year-end 2011. The increase in liquidity is driven largely by the reduction in loan balances in the first nine months of the year. Currently, the FRB balance is higher than the desired balance of between $7 and $10 million. Although excess liquidity is a conservative posture, it is harmful to earnings. Management discusses the Bank’s liquidity position regularly and attempts to balance expected cash flow needs while also planning for unexpected liquidity events. Many of the loan repayments were not expected. As a result, there have been fewer solicitations of time deposits; both local and from the internet.

The Bank’s security portfolio was $38.2 million at September 30, 2012 and $34.6 million at December 31, 2011. Investment activity in the first nine months of the year included purchases of $12.4 million and maturities, pre-payments and calls of $8.3 million. In the first quarter of 2012, one security was sold for a gain of approximately $3,000.

The securities portfolio is a key source of liquidity for the Bank. Given the Bank’s troubled condition there are very few opportunities to secure off-balance-sheet borrowing facilities. Maintaining the unencumbered portion of the Bank’s security portfolio at a level that exceeds its general internal policy is critical and is one of the driving forces behind investment activity. Prior to the Consent Order, the Bank strived to have between 10% and 20% of its investment portfolio unpledged but given the lack of other liquidity resources, the Bank has chosen to maintain a higher level of unpledged investments. At September 30, 2012, 36% of the investment portfolio was unencumbered; this outcome is similar to the 33% that was unpledged on December 31, 2011.

At September 30, 2012, $24.5 million of securities were pledged to public fund customers, the Federal Reserve Discount Window (“Discount Window”) and customer repurchase agreements.

The quality of the investment portfolio has received much scrutiny over the past several years. The plight of the U.S. bond market and U.S. economy in general as well as the European debt crisis have all either directly or indirectly affected security market values. Regardless, the investment portfolio remains strong with an unrealized net gain of $700,000. Included in this total are unrealized losses of only approximately $26,000. At September 30, 2012, there were six securities with an amortized cost of $3.4 million having an unrealized loss. Only one of the six had an unrealized loss longer than 12 months. At year-end 2011, there were seven securities with an amortized cost of $4.1 million having an unrealized loss and two with an unrealized loss longer than 12 months.

At September 30, 2012, the Bank conducted its standard review for other-than-temporary impairment (“OTTI”). The unrealized losses referenced above were not determined to be other-than-temporary given the fact that the decline in value is less than 1%, they are all fully guaranteed by the U.S. government, and the fact that the Bank has the ability and intent to hold them, and it is not likely the Bank will be required to sell the securities prior to them either recovering or maturing. The portfolio will continue to be reviewed for impairment in accordance with the Bank’s investment policy.

Loans held for sale activity during the first nine months of 2012 included $11.7 million of loan originations and $11.4 million of loan sales. The associated gain on the loan sales was $208,000.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Total loans (held for investment) decreased $24.4 million and were $125.2 million at September 30, 2012 down from $149.6 million at December 31, 2011. The decrease in the commercial and commercial real estate loan portfolios comprised 88% of the overall decline. The overall decrease in the loan portfolio changed the concentration slightly. At September 30, 2012 the concentration of commercial and commercial real estate loans was 76%; down slightly from a level of 78% at year-end 2011.  The wholesale focus of the Bank has remained since opening in 1999. During the economic crisis, the credit quality of those borrowers in the two largest portfolio segments deteriorated the most and caused a significant increase in the Bank’s overall risk profile.

To help mitigate the credit risk, the Bank continues to develop and educate lenders and credit staff, and to invest time into the design and overall strengthening of the Company’s credit risk assessment processes. Simply put credit risk is the risk of borrower nonpayment typically on loans although it can be applicable to the investment portfolio as well. In both cases, avoiding portfolio concentrations in any one type of credit or in a specific industry helps to decrease risk; however, the risk of nonpayment for any reason exists with respect to all loans and investments. 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 debt; and in the case of a collateralized loan, the quality of the collateral.

There is a very detailed process that has been developed and implemented by the Bank to estimate credit risk. The process is discussed at length in Note 1 to the Company’s December 31, 2011 financial statements. At each period end, the balance in the allowance for loan losses is based on management’s estimation of probable incurred credit losses utilizing the specified process. Basically, the analysis of the allowance for loan losses is comprised of two portions: general credit allocations and specific credit allocations. General credit allocations are made to various categories of loans based on loan ratings, delinquency trends, historical loss experience as well as current economic conditions. The specific credit allocation includes a detailed review of a borrower and its entire relationship resulting in an allocation being made to the allowance for that particular borrower.  A loan becomes specifically identified when, based on current information and events related to that particular borrower, it is probable that the Company will be unable to collect the scheduled payments of principal and interest according to the contractual terms of the loan agreement.

The allowance for loan losses is adjusted accordingly to maintain an adequate level based on the conclusion of the general and specific analysis. There are occasions when a specifically identified loan requires no allocated allowance for loan losses. To have no allocated allowance for loan loss, a specifically identified loan must be well secured and have a collateral analysis that supports a loan loss reserve allocation of zero.

At September 30, 2012, the allowance for loan losses totaled $3.6 million. During the first nine months of 2012, $75,000 was added to the allowance through the provision expense. At year-end 2011, the allowance for loan losses was $5.3 million. The reduction in the allowance for loan losses is mostly related to net charge offs of $1.8 million occurring in the first three quarters of 2012. The ratio of allowance to gross loans outstanding decreased to a level of 2.88% at September 30, 2012 compared to 3.54% at year-end 2011. Over $1.1 million of the loan charge-offs occurring in the first nine months of 2012 held specific allocations at year-end 2011.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The allocation of the allowance at September 30, 2012 and December 31, 2011 was as follows:

	September 30, 2012					December 31, 2011
			Percent of					Percent of
			Loans in Each					Loans in Each
Balance at End of Period			Category to					Category to
Applicable to:	Amount		Total Loans			Amount		Total Loans
Commercial	$	612,725		31.6	%	$	1,309,632		33.4	%
Commercial Real Estate		2,157,519		44.2			3,386,433		44.4
Consumer		366,768		9.9			410,001		10.9
Residential		154,177		14.3			193,388		11.3
Unallocated		312,218		N/A			0		N/A
Total	$	3,603,407		100	%	$	5,299,454		100	%

The general component of the allowance for loan losses as a percentage of non-specifically identified loans was 1.39% at September 30, 2012, a decrease of 33 basis points from year-end 2011.  At year-end 2011, the general component of the allowance for loan losses was 1.72% of total non-specifically identified loans. Management feels that the trend of the general component of the allowance for loan losses is in line with improvement in the economy, local unemployment, and risk in the portfolio including a reduction in both delinquency and charge-offs.

At September 30, 2012, there is $312,000 of unallocated reserves in the allowance for loan losses.  The unallocated reserve addresses certain broader economic and environmental factors that are not specific to any particular portfolio segment.  As higher periods of loss are removed from the 36-month historical loss calculation, the general component of the allowance decreased as previously discussed.  Based on macro-economic factors, as well as environmental and regulatory considerations, the unallocated portion of the allowance increased from $0 at December 31, 2011 to $76,000 at June 30, 2012 and $312,000 at September 30, 2012. If these unallocated reserves were included in the general component at September 30, 2012, the ratio of reserves to non-specifically identified loans would increase to 1.67% from 1.39%.

At September 30, 2012, the allowance contained $1,720,000 in specific allocations for impaired loans whereas at December 31, 2011 there was $2,991,000 specifically allocated. There was $12.8 million of unpaid principal on impaired loans at September 30, 2012 compared to $15.8 million at year-end 2011. At September 30, 2012, there was $6.1 million of unpaid principal on impaired loans requiring no reserves, a decrease of $1.3 million since year-end 2011.  In the first nine months of 2012, two loans were removed from troubled debt status. The total principal balance of these two loans was $259,000. There was a $33,000 specific allocation for one of the loans at year-end 2011.

Another factor considered in the assessment of the adequacy of the allowance is the quality of the loan portfolio from a past due standpoint. From year-end 2011 to September 30, 2012, the recorded investment in past due and non-accrual loans decreased by $2.6 million. This was evidenced by a $1.2 million decrease in the recorded investment in past due loans still accruing interest and a $1.4 million decrease in the recorded investment in past due, non-accrual loans in the first nine months of 2012.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

There were no accruing loans past due 30-59 days at September 30, 2012; a decrease of $875,000 since December 31, 2011. The decrease is mostly the result of activities on two loans. One loan for $545,000 was partially charged off and the value of the collateral reclassified to foreclosed assets and one for $196,000 was brought current as part of a workout deal.

The recorded investment of accruing loans past due 60-89 days decreased $356,000 since year-end 2011 and was $38,000 at September 30, 2012. The entire balance past due at year-end 2011 was related to one customer. In the first part of 2012, the Bank did a workout with the customer which involved a non-real estate collateral liquidation and a principal paydown. The loans are performing now.  At September 30, 2012 there were five loans comprising the $38,000 past due balance.

There were no loans with a recorded investment past due 90 days and greater at September 30, 2012 still accruing interest. There was $27,000 past due 90 days and greater at year-end 2011.

The Bank’s delinquency is very low compared to prior periods and continues to trend downward. The credit review process will continue to be stringent; however, it is possible that past dues could fluctuate in future periods.

In addition to a decline in delinquency in the first nine months of the year, the recorded investment of non-accrual loans decreased $1.8 million. At September 30, 2012, the recorded investment of non-accrual loans was $4.8 million. From a past due standpoint, 19% of the recorded investment in non-accrual loans were past due greater than 90 days on September 30, 2012; a majority of the non-accrual loans are paying as agreed and will possibly be eligible to return to full accrual in the future.

Overall net charge-offs for the third quarter of 2012 were $718,000 and were $1.8 million for the first nine months of 2012. The corresponding ratio of net charge-offs to average loans for the third quarter of 2012 was 2.15% while the ratio of net charge-offs to average loans was 1.68% for the first nine months of 2012.

There were two primary transactions that account for a majority of the net charge-offs occurring in the third quarter and first nine months of 2012.

In the third quarter of 2012, 88% of the net charge-offs were for one relationship. The entire balance charged off for that relationship was fully allocated for in the allowance for loan losses. The charge-off occurred because the Bank met the Michigan statutory bad debt resolution time limits as a result of protracted litigation. Despite having charged off the loans as regulatorily required, the Bank continues to pursue legal remedies for potential recovery.

The second significant transaction occurred in the first quarter of 2012. A large commercial real estate credit was restructured in a modification that is commonly referred to as an A-B note structure. In these types of modifications, a detailed analysis of the borrower’s financial condition is performed and the total debt is separated into two notes. The first note (“note A”) is underwritten to be supported by current cash flows and collateral and the second note (“note B”) is made for the remaining unsecured debt. Note B is immediately charged-off after closing with collection occurring only after note A is completely repaid. Sixty-six percent of the charge-offs recorded in the first quarter of 2012 was the note B of a commercial real estate restructuring. Ignoring the above

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

two transactions, other charge-offs would have been less than 0.50% of average loans during the first nine months of 2012.

The net charge-offs for the third quarter of 2011 were $323,000 and $1.4 million for the first nine months of 2011. The resulting ratio of net charge-offs to average loans for the third quarter of 2011 was 0.80% and 1.13% for the first nine months of the same year.

Although the nine month ratios of net charge-offs to average loans for both years are not comparable to normal historical charge-off ratios, it is encouraging that many of the recent charge-offs were already specifically identified.

Another risk identified by the Company is interest rate risk. The Company attempts to mitigate interest rate risk in its loan portfolio in many ways. In addition to product diversification, two other methods used are to balance the rate sensitivity of the portfolio and avoid extension risk1.

The loan maturities and rate sensitivity of the loan portfolio at September 30, 2012 are set forth below:

	Within		Three to		One to		After
	Three Months		Twelve Months		Five Years		Five Years		Total
Commercial	$	4,681,848	$	14,123,476	$	16,672,102	$	4,039,199	$	39,516,625
Commercial Real Estate:
General		1,586,953		11,816,984		35,442,597		708,589		49,555,123
Construction		1,347,459		2,181,079		2,273,245		39,949		5,841,732
Consumer:
Lines of credit		646,986		1,076,497		3,434,320		4,664,601		9,822,404
Other		174,020		129,900		1,011,976		770,130		2,086,026
Credit card		58,015		178,329		269,344		0		505,688
Residential		0		66,380		6,400		17,834,253		17,907,033
	$	8,495,281	$	29,572,645	$	59,109,984	$	28,056,721	$	125,234,631
Loans at fixed rates	$	5,836,084	$	21,680,872	$	45,869,900	$	20,325,194	$	93,712,050
Loans at variable rates		2,659,197		7,891,773		13,240,084		7,731,527		31,522,581
	$	8,495,281	$	29,572,645	$	59,109,984	$	28,056,721	$	125,234,631

Since 2008, the Bank’s concentration of fixed rate loans has been increasing. Some of the shift is a factor of the types of loans that have paid off or have been added to the portfolio and some of the change is related to customer preference at the time of renewal. The loan repayments that occurred in the first nine months of 2012 have further impacted the rate distribution of the loan portfolio. At September 30, 2012, there were 75% of the loan balances carrying a fixed rate and 25% a floating rate. The composition of the loan portfolio at year-end 2011 was 71% fixed and 29% floating.

____________________________

1Extension 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 its 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.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

It is likely that future rate movements will be rising given the extended period of low rates that has existed over the past few years. As a result of the current mix of the loan portfolio, management will be challenged to improve loan income in a rising rate environment due to the heavy concentration of fixed rate loans.

Additionally, the maturity distribution of the loan portfolio has lengthened over the last several years. Contributing to the change in distribution is the increase in the mortgage loan portfolio over the past several years. Typically management strives to retain only 10-15% of residential mortgages originated because of the longer contractual terms generally associated with mortgage products. To control extension risk mostly associated with the mortgage business line, management remains focused on originating loans saleable into the secondary market. At September 30, 2012, approximately 22% of the entire loan portfolio had a contractual maturity longer than five years, a level which is within the parameters determined to be acceptable by management.

Premises and equipment were $9.5 million at September 30, 2012. This was a decrease of $936,000 from the balance of $10.4 million on December 31, 2011. In June, the Bank completed the sale of land it had purchased in the fourth quarter of 2006 for expansion of its branching system. The property was located on Apple Avenue in Muskegon County. The book value of the land sold was $788,000. There was a gain recorded of $208,000.

Foreclosed assets were $3.0 million at September 30, 2012 which was a decrease of $283,000 since December 31, 2011. These assets consist of relinquished properties through the collection process which were previously customer collateral supporting various borrowings. These properties are held until they can be sold. In addition to several lot sales during the first nine months of 2012, 11 properties were added, 14 properties sold and one property that had no book value was relinquished to the county. At September 30, 2012 there were 27 real estate holdings and at December 31, 2011 there were 31 real estate holdings.

Deposit balances were $189.3 million at September 30, 2012 down from $191.5 million at December 31, 2011. Since year-end 2011, total deposits declined by $2.2 million or 1%. The decrease was the result of an $11.9 million increase in non-interest bearing deposits being more than offset by total interest bearing deposits decreasing by $14.1 million.

Over 40% of the $11.9 million increase in non-interest bearing demand accounts was the result of one customer transferring from the Bank’s repurchase agreement product into a non-interest demand account. Several other existing business and public fund customers increased their balances since year-end 2011.

Since year-end 2011, interest bearing demand deposit accounts have risen by $3.9 million. The increase is related to the seasonal account activity of two of the Bank’s public fund customers.

More than offsetting the increase in interest bearing demand deposit accounts was a net decline of $19.3 million in the Bank’s time deposit balances in the first nine months of 2012. With a significant amount of unplanned loan repayments, the Bank has not focused on renewing time deposits in an attempt to reduce the liquidity in the Federal Reserve Bank. The reduction since year-end 2011 included a maturity of $3.5 million which was the final brokered time deposit held at the Bank. The Bank’s Consent Order with the FDIC prohibits the use of brokered deposits. The Bank has not issued any brokered deposits since January of 2010.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Repurchase agreement balances were $7.8 million at December 31, 2011 and $8.6 million at September 30, 2012; an increase of $778,000. Several customers increased their balances between the two period ends and completely offset the large transfer that one customer made into the non-interest demand deposit category.

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 collateralized by high quality government securities held in a sub-account within the Bank’s security portfolio. This banking product has gotten more utilization since the FDIC program changed on December 31, 2010. Customers with investable dollars exceeding the FDIC limits are utilizing this account type because they are seeking higher interest rates while mitigating their risk.

Shareholders’ equity was negative with a balance of $(1.1 million) on September 30, 2012. On December 31, 2011 the balance was $(1.4 million). There was an improvement of $271,000 which was made up of income recorded in the first nine months of 2012 and a slight increase in accumulated other comprehensive income (security market value adjustments).

The Bank’s capital ratios have risen since year-end 2011. At September 30, 2012, the Bank’s total risk-based capital ratio was 7.80% and its tier one to average assets ratio was 4.25%.  The Bank’s total risk-based capital ratio at December 31, 2011 was 6.40%. Its tier one to average assets ratio was 3.79% at year-end 2011. The total risk-based capital ratio improved as a result of recorded earnings and because of the favorable change in the mix of the Bank’s net risk-weighted assets. In spite of the improvement, on both period ends the Bank was considered undercapitalized according to prompt corrective action regulations administered by federal banking agencies.

Under the Consent Order, the Bank is required to have and maintain its level of tier one capital, as a percentage of its total assets, at a minimum of 8.5%, and its level of qualifying total capital, as a percentage of risk-weighted assets, at a minimum of 11%.   The Consent Order capital requirements were effective beginning with the December 31, 2010 capital reporting period.  The Bank was not in compliance with required capital ratios at any of the December 2010, 2011 or September 2012 capital reporting periods. In order to attain the level of capital required by the Consent Order, the Bank would have needed additional capital of $8,906,000 on September 30, 2012 based on its asset mix and size. This is a decrease of $1,414,000 compared to the $10,320,000 that would have been needed on December 31, 2011.

The Directive, issued by the FDIC to the Bank on August 17, 2011, stipulated that the Bank be restored to an “adequately capitalized” capital category by October 17, 2011. To reach a level of adequately capitalized, according to FDIC prompt corrective action guidance, the Bank would have needed a capital contribution of $277,000 based on its asset mix on September 30, 2012. Although the board made efforts to secure funding and comply with the Directive, they were not successful. As such, the Bank was not in compliance with the Directive by the required date and remains out of compliance. The board informed the FDIC in a letter dated October 14, 2011 that it was unable to comply with the Directive. There has been no further communications with the FDIC regarding the Directive. The board’s effort to garner capital for the Bank is continuing.

RESULTS OF OPERATIONS

Net income recorded for the first nine months of 2012 was $259,000. There were losses of $1.9 million recorded for the first nine months of 2011; an improvement of $2.2 million between similar periods of 2012 and 2011. The

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

corresponding basic and diluted earnings per share for the first nine months of 2012 was $0.18. The basic and diluted loss per share for the first nine months of 2011 was $(1.32).

The Company recorded net income of $2,000 for the third quarter of 2012; unfortunately that level of earnings results in a basic and diluted earnings per share of $0.00. Conversely, there was a loss of $685,000 recorded in 2011’s third quarter. The corresponding basic and diluted loss per share was $(0.47).

The income recorded in the first nine months of 2012 stems primarily from reduced expenses related to administering troubled assets and a gain on the disposal of a capital asset. The loan loss provision, foreclosed asset impairments and other collection expenses totaled $807,000 for the first nine months of 2012. For the similar period in 2011 the same expenses totaled $2.9 million. For the third quarter of 2012, loan loss provision, foreclosed asset impairments and other collection expenses totaled $231,000; a decrease of $911,000 from the third quarter of 2011. Expenses related to administering troubled assets have declined markedly over the last several quarters. With the stabilization in the local economy and minimal delinquency, it is reasonable to assume that troubled asset expenses have stabilized and may possibly continue to decline.

For the first nine months of 2012, the annualized return on the Company’s average total assets was 0.16% compared to (1.11)% for the first nine months of 2011. For the third quarter of 2012, the annualized return on the Company’s average total assets was 0.00%. For the third quarter of 2011, the ratio was (1.19)%. The Company’s annualized return on average equity was (27.18)% for the first nine months of 2012 and (959.51)% for the first nine months of 2011. The ratio of average equity to average assets was (0.60)% for the first nine months of 2012 and 0.12% for the first nine months of 2011. The ratio was (0.51)% for the third quarter of 2012 and (0.03)% for the same period in 2011. Although the Company had recorded earnings in the third quarter and first nine months of 2012, the shareholder’s equity of the Company was still a negative number making the equity ratios referenced above negative and appear contradictory to the operating results.

Another component of the Company’s revenue is its net interest income. Although the Company’s net interest income was lower for the first nine months of 2012 compared to the similar period in 2011, the corresponding net interest margin was better mostly as a result of improvements made to the Company’s cost of average funds. 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.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

	Nine Months ended September 30,
	2012								2011
	Average					Average			Average				Average
	Balance			Interest		Rate			Balance		Interest		Rate
Assets
Federal funds sold and interest-
bearing deposits with banks	$	21,683,580		$	39,456		0.24	%	$	21,617,008	$	39,448		0.24	%
Securities		36,153,180			511,709		1.89			35,703,465		617,650		2.31
Loans (including held for sale
and non accrual)		140,298,678			6,199,527		5.89			163,306,014		7,567,907		6.18
		198,135,438			6,750,692		4.54			220,626,487		8,225,005		4.97
Other assets		12,855,802								13,442,875
	$	210,991,240							$	234,069,362
Liabilities and Shareholders’ Equity
Interest-bearing deposits	$	153,248,982		$	1,094,497		0.95		$	176,738,287	$	2,302,079		1.74	%
Repurchase agreements and
FRB borrowings		9,606,429			54,593		0.76			9,192,295		52,200		0.76
Subordinated debentures and
notes payable		9,500,000			322,937		4.53			9,500,000		311,793		4.38
		172,355,411			1,472,027		1.14			195,430,582		2,666,072		1.82
Non-interest-bearing deposits		38,559,716								37,379,218
Other liabilities		1,349,193								989,715
Shareholders’ Equity		(1,273,080	)							269,847
	$	210,991,240							$	234,069,362
Net interest income					5,278,665							5,558,933
Net interest spread on earning assets							3.40	%						3.15	%
Net interest margin on earning assets							3.55	%						3.36	%
Average interest-earning assets to
average interest-bearing liabilities							114.96	%						112.89	%

The net interest spread on average earning assets increased 25 basis points to 3.40% in the past twelve months. The net interest margin increased by 19 basis points from 3.36% for the first nine months of 2011 to 3.55% for the first nine months of 2012. The net interest income for the first nine months of 2012 was $5.3 million compared to a figure of $5.6 million for the same nine months in 2011. Although there were $22.5 million fewer average earning assets in the first nine months of 2012 compared to the similar period in 2011, the Company’s net interest income only decreased by $280,000 and the net interest margin improved. Improvement stemmed primarily from a change in the mix of funding resources and a decrease in the yield paid on interest-bearing liabilities.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The average rate earned on interest earning assets was 4.54% for the nine month period ending September 30, 2012 compared to 4.97% for the same period in 2011. The main contributing factor was a reduction in the loan portfolio, the Company’s largest earning asset category. As the economy improves, businesses become healthier which strengthens their financial condition and allows them more banking options. As economic activity returns, many businesses are using excess liquidity to repay loans while others are pursuing lower rate financing at other financial institutions. The Company’s average loan portfolio is $23.0 million smaller than it was for the first nine month period of 2011. Management will match competitor pricing to retain a customer when the rates adequately reflect borrower risk. Since the Bank’s internal prime lending rate is 175 basis points above the Wall Street Journal Prime Lending Rate, there is a lot of competitive pressure to revisit pricing on those customers that have recovered and are experiencing an improved financial condition.

Also contributing to the decreased yield on average earning assets is the marked decrease in the yield earned on the investment portfolio. Throughout last year, as securities matured, the replacement securities purchased yielded lower rates as a result of differences in the rate environment.

Fortunately, decreases to the overall yield on interest earning assets were more than offset by rate reductions on the funding side. Management spends a significant amount of time managing the continued improvement in the cost of funds, especially in light of the restrictions placed by the Consent Order. Interest expense incurred on rate-bearing liabilities improved by 68 basis points when comparing the first nine months of 2012 to that of the similar period in 2011; a majority of the improvement was a 65 basis point reduction in the average rate paid on the time deposit portfolio over the last twelve months. With loan repayments in the first nine months of 2012, the Bank has been able to let maturing time deposits go without replacing them. When funding has been needed over the last twelve months, the Bank has been successful at securing lower rates.

The Bank’s customer repurchase agreement balance grew slightly in the first nine months of 2012. The average outstanding in the first nine months of 2012 was $414,000 more than what it was in the same nine month period of 2011. The rate paid remained the same.

Finally, the Company’s average rate paid on notes payable and subordinated debentures increased by 15 basis points between the first nine months of 2012 and the first nine months of 2011. The Company’s subordinated debt carried an average rate of 2.80% in the first nine months of 2012 which is roughly 30 basis points higher than an average rate of 2.50% paid for the same period in 2011.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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, 2012 and 2011 is in the table below.

	Three Months ended September 30,
	2012								2011
	Average					Average			Average					Average
	Balance			Interest		Rate			Balance			Interest		Rate
Assets
Federal funds sold and interest-
bearing deposits with banks	$	25,987,402		$	15,841		0.24	%	$	20,881,763		$	13,018		0.25	%
Securities		36,423,425			162,014		1.78			35,169,116			192,928		2.19
Loans (including held for sale
and non accrual)		133,689,544			1,946,158		5.82			160,660,628			2,467,854		6.14
		196,100,371			2,124,013		4.33			216,711,507			2,673,800		4.94
Other assets		13,244,006								13,112,538
	$	209,344,377							$	229,824,045
Liabilities and Shareholders’ Equity
Interest-bearing deposits	$	148,153,284		$	333,829		0.90		$	173,045,897		$	725,662		1.68	%
Repurchase agreements and
FRB borrowings		8,432,594			15,574		0.74			10,492,999			20,583		0.78
Subordinated debentures and
notes payable		9,500,000			108,093		4.55			9,500,000			104,742		4.41
		166,085,878			457,496		1.10			193,038,896			850,987		1.76
Non-interest-bearing deposits		42,840,183								35,570,309
Other liabilities		1,493,868								1,289,058
Shareholders’ Equity		(1,075,552	)							(74,218	)
	$	209,344,377							$	229,824,045
Net interest income					1,666,517								1,822,813
Net interest spread on earning assets							3.23	%							3.18	%
Net interest margin on earning assets							3.40	%							3.36	%
Average interest-earning assets to
average interest-bearing liabilities							118.07	%							112.26	%

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Similar to the comparison of the year to date net interest income results above; there was an overall decrease in net interest income between the third quarter results of 2012 and that of 2011. Net interest income declined by $156,000. Decreases to the blended rate earned on the average earning assets fell by 61 basis points mostly due to the excess liquidity carried during the quarter from loan repayments. Offsetting the decline in the blended rate earned on average earning assets was a 66 basis point improvement in the Company’s average cost of funds. As a result, the net interest spread rose by 5 basis points between the third quarter of 2011 and the similar period in 2012. The net interest margin on earning assets was 3.40% for the third quarter of 2012; an improvement of 4 basis points compared to the third quarter of 2011. Given the unexpected loan repayments and the higher than expected liquidity at the FRB, it may be difficult to continue improving the Company’s net interest margin in the last quarter of 2012. Any anticipated improvements to the net interest margin are likely to come from utilizing excess liquidity to fund time deposit maturities and to continue to reprice new time deposits to current rates.

In general, the rate environment remains at historically low levels and management is continually challenged to improve its mix of assets and its net interest income thus asset liability management remains an important tool for assessing interest rate sensitivity; it also provides a tool for monitoring liquidity. 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.

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.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Details of the repricing gap at September 30, 2012 were:

	Interest Rate Sensitivity Period
	Within Three			Three to Twelve			One to Five		After Five
	Months			Months			Years		Years		Total
Earning assets
Interest-bearing deposits
in other financial institutions	$	24,661,503		$	0		$	0	$	0	$	24,661,503
Securities (including FHLB stock)		4,651,340			7,790,888			21,261,020		4,956,090		38,659,338
Loans held for sale		23,010			70,675			422,135		5,520,644		6,036,464
Loans		46,192,630			19,905,495			43,029,144		16,107,362		125,234,631
		75,528,483			27,767,058			64,712,299		26,584,096		194,591,936
Interest-bearing liabilities
Savings and checking		51,536,408			0			0		0		51,536,408
Time deposits <$100,000		15,666,096			28,280,514			39,404,948		0		83,351,558
Time deposits >$100,000		906,488			5,214,276			3,127,359		0		9,248,123
Repurchase agreements and
Federal funds purchased		8,593,208			0			0		0		8,593,208
Notes payable and other
borrowings		9,500,000			0			0		0		9,500,000
		86,202,200			33,494,790			42,532,307		0		162,229,297
Net asset (liability) repricing gap	$	(10,673,717	)	$	(5,727,732	)	$	22,179,992	$	26,584,096	$	32,362,639
Cumulative net asset (liability)
repricing gap	$	(10,673,717	)	$	(16,401,449	)	$	5,778,543	$	32,362,639

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 more rate bearing products have an opportunity to reprice during this period. If the rate environment remains flat like the FRB has forecasted, a negative repricing gap should be helpful for further reduction to the Company’s overall interest expense which could translate into higher net interest income and an increased net interest margin assuming there is not continued shrinkage or significant decline in the interest earned on the Company’s loan portfolio. If the Company’s gap position remains negative when interest rates begin to rise, there will likely be a negative effect on net interest income. The interest rate sensitivity table simply illustrates what the Company is contractually able to change in certain time frames.

The provision for loan losses for the first nine months of 2012 was $75,000 compared to $1.5 million for first nine months of 2011. The third quarter provision for loan losses was $345,000 for 2011 but none was recorded for the third quarter of 2012. The provision expenses are associated with changes in historical loss calculations, economic condition as well as delinquency, loan charge offs and downgrades. A methodical assessment of these factors generates the reserves required for the risk in the Bank’s loan portfolio. Over the past few years, general allocations to the loan loss reserve were increasing as a result of the weakening economy and the emphasis being placed on recent loss history. Currently, general allocations are declining as a result of stabilization in the local economy and improved trends in delinquency and charge off activity and decreasing loan balances for which reserves are made.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Specific allocations to the loan loss reserve have also decreased in the first nine months of the year. At September 30, 2012, the allowance for loan loss included specific allocations of $1.7 million, approximately $1.3 million less than at December 31, 2011. At September 30, 2011, specific allocations were $2.4 million or $691,000 more than the same period end in 2012.

The allowance for loan losses is an estimate. 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, actual loan loss experience and the environmental factors related to lending and collateral.

Non-interest income recorded in the first nine months of 2012 was $1.3 million compared to $1.5 million recorded for the similar period in 2011. Decreases in recurring income sources such as service charges on deposits and overdraft fee income are responsible for a portion of the decline. Two large differences when comparing the first three quarters of 2011 and 2012 basically offset each other; gains and losses on foreclosed asset sales and the gain on the sale of premises and equipment.

In the first nine months of 2012, foreclosed asset sales resulted in losses of $40,000. In the first nine months of 2011, foreclosed asset sales resulted in a gain of $196,000. There is a $236,000 unfavorable differential between the periods. Nearly offsetting this was a gain of $208,000 recorded in 2012’s second quarter. The Bank sold land that was originally acquired to build a fifth banking branch. There were no sales of premises and equipment in the first nine months of 2011.

A majority of the decline between the first nine months of 2012 and that of 2011 in other non-interest income stems from the $76,000 decrease in loan servicing income on Small Business Administration (“SBA”) loans. In addition to receiving income for servicing SBA loan payments, the Company also recognizes changes in the fair value of its SBA servicing rights through the same income account. In the first quarter of 2011, the Bank sold the guaranteed portion of three SBA loans and recorded the initial fair market value through income according to the Company’s chosen accounting method for servicing rights. In the second quarter of 2012, the Bank repurchased one of the sold loans which eliminated the servicing right and resulted in another fair value adjustment through servicing income. For more detailed information see Note 1 to the Company’s 2011 Annual Report.

Non-interest income for the third quarter of 2012 was $419,000 compared to $586,000 of non-interest income in the third quarter of 2011; $167,000 less. The largest difference between the two operating periods was a $201,000 net gain on the sale of foreclosed property which occurred in 2011’s third quarter. Foreclosed property sales were only $2,000 in 2012’s similar quarter. From a recurring income standpoint, there has been an increase in revenue generated from originating and selling mortgage loans. Gains on the sale of mortgage loans were $105,000 in the third quarter of 2012. This outcome was $82,000 more than the similar period in 2011.

Non-interest expenses for the first nine months of 2012 were $6.2 million. Non-interest expenses for the first nine months of 2011 were $7.4 million. Decreases to salary and benefit expenses and impairment on foreclosed assets comprised 85% of the decrease in the first nine months of the year. Non-interest expenses were $2.1 million for the third quarter of 2012 compared to $2.7 million for the similar period in 2011. The decline of $666,000 was attributable to reductions in the same two non-interest expense categories.

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COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Salary and benefit expenses, the largest category of non-interest expenses, were $2.8 million for the first nine months of 2012. For the similar period in 2011, the total was $3.1 million. There were on average 6 fewer full time equivalent (“FTE”) employees when comparing the two time periods. A majority of the decrease was related to retirements. In the last twelve months, one part time and three full time employees retired. Other vacancies were related to the timing of turnover and may not be a permanent decrease in FTE’s. Salary and benefit expenses for the third quarter of 2012 were $940,000, $78,000 less than the total for the same period in 2011.

There were foreclosed asset impairment charges of $277,000 in the first nine months of 2012. These results compare to $1.0 million in the first nine months of 2011. In the third quarter of 2012, foreclosed asset impairment charges were $92,000 or $553,000 less than the like period in 2011. During the time that foreclosed real properties are waiting to be sold, there will be occasions that the Bank will need to reevaluate the individual market value of each property. If there is evidence that the fair value has declined since the last evaluation, the Bank will incur an impairment charge in order to properly reflect the fair value of the asset at the end of the reporting period. Although impairment charges continue to occur, the magnitude of the adjustments has slowed. The taper is caused by two things, the Bank’s portfolio of foreclosed real property is declining and the values of the properties within the portfolio have essentially stabilized. Actually in the past few months, internal and external evaluations on local properties have often been coming in above the carrying value. At September 30, 2012, there were 27 foreclosed assets totaling $3.0 million.

There was no income tax expense in either the first nine months of 2012 or that of 2011. However, it is estimated that the profits recorded by the Company in the first nine months of 2012 have resulted in a small alternative minimum tax liability. The Company will continue to monitor the situation and make adjustments as appropriate.

ITEM 3.           QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable for smaller reporting companies.

ITEM 4.           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, 2012. 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, 2012. There have been no significant changes in the internal controls over financial reporting during the quarter ended September 30, 2012, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

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COMMUNITY SHORES BANK CORPORATION

PART II – OTHER INFORMATION

ITEM 1.           LEGAL PROCEEDINGS

In the opinion of management, the Company and its subsidiaries are not a party to any current legal proceedings that are expected to have a material adverse effect on their financial condition, either individually or in the aggregate.

ITEM 1A.        RISK FACTORS

Not applicable for smaller reporting companies.

ITEM 2.           UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The Company made no unregistered sale of equity securities, and did not purchase any of its equity securities, during the quarter ended September 30, 2012.

Holders of Company common stock are entitled to receive cash dividends to the extent that they are declared from time to time by the Company's Board of Directors.  To date, the Company's Board of Directors has never declared a cash dividend.  The Company may only pay cash dividends out of funds that are legally available for that purpose.  The Company is a holding company and substantially all of its assets are held by its subsidiaries.  The Company's ability to pay cash dividends to its shareholders depends primarily on the Bank's ability to pay cash dividends to the Company.  Cash dividend payments and extensions of credit to the Company from the Bank are subject to legal and regulatory limitations, generally based on capital levels and current and retained earnings, imposed by law and regulatory agencies with authority over the Bank.  The ability of the Bank to pay cash dividends is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements.  Under the Consent Order and Written Agreement, the Bank is precluded from paying dividends to the Company and the Company may not receive dividends from the Bank.

Under the terms of the subordinated debentures that the Company issued to the Trust, the Company is precluded from paying cash dividends on the Company's common stock if an event of default has occurred and is continuing under the subordinated debentures, or if the Company has exercised its right to defer payments of interest on the subordinated debentures, until the deferral ends.  In May of 2010, the Company gave notice that it was deferring the regularly scheduled quarterly interest payments on the subordinated debentures beginning with the quarterly interest payment that was scheduled to be paid on June 30, 2010.  So until the deferral ends, the terms of the subordinated debentures preclude the Company from paying any dividends on the common stock.  If the Company had any preferred stock outstanding, it would similarly be precluded from paying any dividend on the preferred stock.

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COMMUNITY SHORES BANK CORPORATION

ITEM 3.          DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4.           MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.          OTHER INFORMATION

None.

ITEM 6.          EXHIBITS

EXHIBIT NO.	EXHIBIT DESCRIPTION
3.1	Articles of Incorporation are incorporated by reference to exhibit 3.1 of the Company’s September 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).
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 Chief Executive Officer Certification.
32.2	Section 1350 Chief Financial Officer Certification.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	COMMUNITY SHORES BANK CORPORATION
November 14, 2012	By:	/s/ Heather D. Brolick
Date		Heather D. Brolick
		President and Chief Executive Officer
		(principal executive officer)
November 14, 2012	By:	/s/ Tracey A. Welsh
Date		Tracey A. Welsh
		Senior Vice President, Chief Financial Officer and Treasurer
		(principal financial and accounting officer)

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EXHIBIT INDEX

EXHIBIT NO.	EXHIBIT DESCRIPTION
3.1	Articles of Incorporation are incorporated by reference to exhibit 3.1 of the Company’s September 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).
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 Chief Executive Officer Certification.
32.2	Section 1350 Chief Financial Officer Certification.

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