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EX-31.2 - EXHIBIT 31.2 - COMMUNITY SHORES BANK CORPv344831_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - COMMUNITY SHORES BANK CORPv344831_ex31-1.htm
EX-32.1 - EXHIBIT 32.1 - COMMUNITY SHORES BANK CORPv344831_ex32-1.htm
EX-32.2 - EXHIBIT 32.2 - COMMUNITY SHORES BANK CORPv344831_ex32-2.htm

 

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 March 31, 2013                                                                                                                 

 

or

 

¨ 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.

x Yes ¨No

 

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).

¨ Yes x No

 

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 ¨ Accelerated filer ¨ Non-accelerated filer ¨   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).

¨ Yes xNo

 

At May 1, 2013, 1,468,800 shares of common stock were outstanding.

 

 
 

 

Community Shores Bank Corporation Index

 

    Page No.
PART I. Financial Information
     
  Item 1. Financial Statements 1
     
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 41
     
  Item 3. Quantitative and Qualitative Disclosures about Market Risk 57
     
  Item 4. Controls and Procedures 57
     
PART II. Other Information  
     
  Item 1. Legal Proceedings 58
     
  Item 1A. Risk Factors 58
     
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 58
     
  Item 3. Defaults upon Senior Securities 59
     
  Item 4. Mine Safety Disclosures 59
     
  Item 5. Other Information 59
     
  Item 6. Exhibits 59
     
  Signatures 60

 

 
 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1.FINANCIAL STATEMENTS

 

COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   March 31,   December 31, 
   2013   2012 
   (unaudited)   (audited) 
ASSETS          
Cash and due from financial institutions  $2,093,442   $2,979,189 
Interest-bearing deposits in other financial institutions   21,418,199    17,317,926 
Total cash and cash equivalents   23,511,641    20,297,115 
Securities available for sale (at fair value)   38,448,580    41,460,396 
Loans held for sale   5,270,597    6,040,869 
Loans   126,320,598    125,830,250 
Less: Allowance for loan losses   3,302,297    3,382,977 
Net loans   123,018,301    122,447,273 
Federal Home Loan Bank stock (at cost)   450,800    450,800 
Premises and equipment, net   9,362,015    9,420,886 
Accrued interest receivable   584,029    592,043 
Foreclosed assets   3,098,532    2,806,781 
Other assets   954,871    715,200 
Total assets  $204,699,366   $204,231,363 
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Deposits          
Non-interest-bearing  $31,966,192   $40,271,190 
Interest-bearing   151,930,993    143,905,303 
Total deposits   183,897,185    184,176,493 
Federal funds purchased and repurchase agreements   10,174,229    10,190,059 
Subordinated debentures   4,500,000    4,500,000 
Notes payable   1,280,000    5,000,000 
Accrued expenses and other liabilities   858,753    1,603,907 
Total liabilities   200,710,167    205,470,459 
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   (9,512,060)   (14,816,593)
Accumulated other comprehensive income   204,568    280,806 
Total shareholders’ equity   3,989,199    (1,239,096)
Total liabilities and shareholders’ equity  $204,699,366   $204,231,363 

 

See accompanying notes to consolidated financial statements.

 

-1-
 

 

COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(UNAUDITED)

 

   Three Months Ended   Three Months Ended 
   March 31, 2013   March 31, 2012 
Interest and dividend income          
Loans, including fees  $1,876,474   $2,153,005 
Securities   156,889    175,194 
Federal funds sold, FHLB dividends and other income   10,329    11,735 
Total interest income   2,043,692    2,339,934 
Interest expense          
Deposits   278,912    404,273 
Repurchase agreements, federal funds purchased, and other debt   15,214    17,390 
Federal Home Loan Bank advances and notes payable   32,717    107,979 
Total interest expense   326,843    529,642 
Net Interest Income   1,716,849    1,810,292 
Provision for loan losses   0    75,035 
Net Interest Income After Provision for Loan Losses   1,716,849    1,735,257 
Non-interest income          
Service charges on deposit accounts   149,451    164,210 
Mortgage loan referral fees   0    3,279 
Gain on sale of loans   67,243    38,089 
Gain on sale of securities   0    2,856 
Loss on sale of foreclosed assets   0    (48,797)
Gain on sale of premises and equipment   1,000    0 
Gain on the extinguishment of debt   5,262,653    0 
Other   156,276    142,009 
Total non-interest income   5,636,623    301,646 
Non-interest expense          
Salaries and employee benefits   914,910    969,764 
Occupancy   167,030    162,843 
Furniture and equipment   106,043    101,171 
Advertising   15,011    13,880 
Data processing   146,684    133,519 
Professional services   90,648    75,652 
Foreclosed asset impairment   7,599    91,142 
FDIC insurance   172,841    183,868 
Other   323,173    369,165 
Total non-interest expense   1,943,939    2,101,004 
Income (Loss) Before Federal Income Taxes   5,409,533    (64,101)
Federal income tax expense   105,000    0 
Net Income (Loss)  $5,304,533   $(64,101)
Weighted average shares outstanding   1,468,800    1,468,800 
Diluted average shares outstanding   1,468,800    1,468,800 
Basic earnings (loss) per share  $3.61   $(0.04)
Diluted earnings (loss) per share  $3.61   $(0.04)

 

See accompanying notes to consolidated financial statements.

 

-2-
 

 

COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

 

   Three Months Ended   Three Months Ended 
   March 31, 2013   March 31, 2012 
         
Net income (loss)  $5,304,533   $(64,101)
           
Other comprehensive income (loss):          
Unrealized holding losses on available for sale securities   (76,238)   (39,437)
Less reclassification adjustments for gains later recognized in income   0    (2,856)
Net unrealized loss   (76,238)   (42,293)
Tax effect   0    0 
Total other comprehensive loss   (76,238)   (42,293)
           
Comprehensive income (loss)  $5,228,295   $(106,394)

 

See accompanying notes to consolidated financial statements.

 

-3-
 

 

COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

 

               Accumulated     
               Other   Total 
       Common   Retained   Comprehensive   Shareholders’ 
   Shares   Stock   Deficit   Income   Equity 
                     
Balance at January 1, 2012   1,468,800   $13,296,691   $(15,084,431)  $367,358   $(1,420,382)
                          
Net loss             (64,101)        (64,101)
Other comprehensive loss                  (42,293)   (42,293)
                          
Balance at March 31, 2012   1,468,800   $13,296,691   $(15,148,532)  $325,065   $(1,526,776)
                          
Balance at January 1, 2013   1,468,800   $13,296,691   $(14,816,593)  $280,806   $(1,239,096)
                          
Net income             5,304,533         5,304,533 
Other comprehensive loss                  (76,238)   (76,238)
                          
Balance at March 31, 2013   1,468,800   $13,296,691   $(9,512,060)  $204,568   $3,989,199 

 

See accompanying notes to consolidated financial statements.

 

-4-
 

 

COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

   Three Months Ended   Three Months Ended 
   March 31, 2013   March 31, 2012 
Cash flows from operating activities          
Net income (loss)  $5,304,533   $(64,101)
Adjustments to reconcile net income (loss) to net cash from operating activities:          
Provision for loan losses   0    75,035 
Depreciation and amortization   100,643    100,952 
Net amortization of securities   98,256    74,320 
Net realized gain on sale of securities   0    (2,856)
Net realized gain on sale of loans   (67,243)   (38,089)
Net realized loss on sale of foreclosed assets   0    48,797 
Net realized gain on sale of premises and equipment   (1,000)   0 
Net realized gain on the extinguishment of debt   (5,262,653)   0 
Foreclosed asset impairment   7,599    91,142 
Originations of loans for sale   (3,319,130)   (2,748,439)
Proceeds from loan sales   3,162,248    2,198,589 
Net change in:          
Accrued interest receivable and other assets   (231,657)   (102,072)
Accrued interest payable and other liabilities   17,499    (10,789)
Net cash used in operating activities   (190,905)   (377,511)
Cash flows from investing activities          
Activity in available for sale securities:          
Sales   0    257,997 
Maturities, prepayments and calls   2,837,322    1,812,955 
Purchases   0    (5,159,391)
Loan originations and payments, net   42,620    13,040,756 
Additions to premises and equipment, net   (41,772)   (6,312)
Proceeds from the sale of premises and equipment   1,000    0 
Proceeds from the sale of foreclosed assets   81,399    342,882 
Net cash from investing activities   2,920,569    10,288,887 
Cash flows from financing activities          
Net change in deposits   (279,308)   8,628,594 
Net change in federal funds purchased and repurchase agreements   (15,830)   2,257,122 
Other borrowing activity:          
Repayment of note payable   (500,000)   0 
Issuance of senior debt   1,280,000    0 
Net cash from financing activities   484,862    10,885,716 
Net change in cash and cash equivalents   3,214,526    20,797,092 
Beginning cash and cash equivalents   20,297,115    8,919,568 
Ending cash and cash equivalents  $23,511,641   $29,716,660 
Supplemental cash flow information:          
Cash paid during the period for interest  $283,969   $423,361 
Transfers from loans to foreclosed assets   380,749    298,628 
Transfers from loans held for sale to portfolio   994,397    0 

 

See accompanying notes to consolidated financial statements.

 

-5-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.BASIS OF PRESENTATION, LOAN POLICY AND RECENT DEVELOPMENTS:

 

BASIS OF PRESENTATION: The unaudited, consolidated financial statements as of and for the three months ended March 31, 2013 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 March 31, 2013 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, 2012. Some items in the prior year financial statements may be reclassified to conform to the current presentation.

 

LOAN POLICY: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs and an allowance for loan losses.The loan portfolio consists of the following segments:

 

Commercial- Loans to businesses that are sole proprietorships, partnerships, limited liability companies and corporations. These loans are for commercial, industrial, or professional purposes. The risk characteristics of these loans vary based on the borrowers business and industry as repayment is typically dependent on cash flows generated from the underlying business.

 

Commercial Real Estate- Loans to individuals or businesses that are secured by improved and unimproved vacant land, farmland, commercial real property, multifamily residential properties, and all other conforming, nonresidential properties. Proceeds may be used for land acquisition, development or construction. These loans typically fall into two general categories: property that is owner occupied and income or investment property. Owner occupied commercial real estate loans typically involve the same risks as commercial and industrial loans however the underlying collateral is the real estate which is subject to changes in market value after the loan’s origination. Adverse economic events and changes in real estate market valuations generally describe the risks that accompany commercial real estate loans involving income or investment property. The ability of the borrower to repay tends to depend on the success of the underlying project or the ability of the borrower to sell or lease the property at certain anticipated values.

 

Consumer- Term loans or lines of credit for the purchase of consumer goods, vehicles or home improvement. The risk characteristics of the loans in this segment vary depending on the type of collateral but for the most part repayment is expected from an individual continuing to generate a cash flow that supports the calculated payment obligation. Secondary support could involve liquidation of collateral.

 

-6-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

Residential- Loans to purchase or refinance single family residences. The risks associated with this segment are similar to the risks for consumer loans as far as individual payment obligations however the underlying collateral is the real estate. Real estate is subject to changes in market valuation and can be unstable for a variety of reasons.

 

For all loan segments, interest income is accrued on the unpaid principal using the interest method assigned to the loan product and includes amortization of net deferred loan fees and costs over the loan term. Interest income is not reported when full loan repayment is in doubt. A loan is moved to non-accrual status when it is past due over 90 days unless the loan is well secured and in the process of collection. If a loan is not past due but deemed to be impaired it may also be moved to non-accrual status. These rules apply to loans in all segments. However certain classes of loans in the consumer segment may simply get charged-off as opposed to moving to non-accrual status.

 

All interest accrued but not received for a loan placed on non-accrual is reversed against interest income at the time the loan is assigned non-accrual status. Payments received on such loans are applied to principal when there is doubt about recovering the full principal outstanding. Loans are eligible to return to accrual status after six months of timely payment and future payments are reasonably assured.

 

The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and from recoveries of previously charged-off loans and decreased by charge-offs.

 

The allowance for loan loss analysis is performed monthly. Management’s methodology consists of specific and general components. The general component covers non-impaired loans and is based on historical loss experience adjusted for current economic factors.

 

The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Bank over the most recent 12 quarters. The historical loss experience is recalculated at the end of each quarter. This actual loss experience is supplemented with current economic factors based on the risks present for each portfolio segment. These current economic factors are also revisited at the end of each quarter and include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; quality of loan review system; degree of oversight by the Board of Directors; national and local economic trends and conditions; industry conditions; competition and legal and regulatory requirements; and effects of changes in credit concentrations. There were no significant changes to this methodology in 2012.

 

For the commercial and commercial real estate portfolio segments, the historical loss is tracked by original loan grade. The Bank utilizes a numeric grading system for commercial and commercial real estate loans. Grades are assigned to each commercial and commercial real estate loan by assessing information about the specific borrower’s situation and the estimated collateral values. The description of the loan grade criteria is included in Note 3. The most significant risks to the commercial and commercial real estate segments are the level of development and sales of real estate and the collateral values.  Locally and nationally, real estate development and sales activity is slowly picking up but has not yet returned to pre-recession levels. There are widespread pockets of value stabilization but in some cases real estate values can be erratic for properties such as golf courses and non-owner occupied office space. Even so impaired loan charge-off activity directly related to falling collateral values has been less frequent. In 2012, with charge-off activity lessening, the calculated historical loss factor assigned to general allocations was reduced.

 

-7-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

Within the commercial and industrial and commercial real estate portfolios, there are classes of loans with like risk characteristics that are periodically segregated because management has determined that the historical losses or current factors are unique and ought to be considered separately from the entire segment.

 

For the consumer segment, historical loss experience is based on the actual loss history of the following four classes; general consumer loans, personal lines of credit, home equity lines of credit and credit cards. The level of delinquencies and charge-off experience directly impacts the general allocations to the consumer classes. Both delinquencies and charge-offs have gone down in the last year allowing a reduction of the general allocations in the allowance for loan losses.

 

The residential segment loss experience is not segregated by grades or classes. The level of delinquencies, charge-off experience, and direction of real estate values directly impacts the general allocations to the residential real estate segment. Stabilizing real estate values have resulted in reduced general allocations in the allowance for loan losses.

 

The specific component of the allowance for loan losses relates to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and are classified as impaired.

 

Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.

 

Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

 

Any loan within a segment can be considered for individual impairment if it meets the above criteria. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral.

 

Allocations of the allowance may be made for specific loans and groups, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. Loan balances are generally charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Statutorily, the Bank must charge-off any bad debt that reaches delinquency of 360 days. In the case of an impaired loan, management typically charges off any portion of the debt that is unsecured based on an internal analysis of future cash flows and or collateral.

 

There was no material change in the allowance for loan loss methodology in the first quarter of 2013.

 

-8-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

RECENT DEVELOPMENTS: In February 2013, the FASB issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which is intended to improve the reporting of reclassifications out of accumulated other comprehensive income.  The ASU requires an entity to report, either on the face of the income statement or in the notes to the financial statements, the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in the income statement.  This ASU was adopted by the Company prospectively in the first quarter of 2013.

 

In 2012, the Company recorded consolidated net income for the first time since 2006. The trend of profitability continued in the first quarter of 2013. As a result of a $5.3 million gain on extinguishment of debt recorded late in the first quarter, the Company’s consolidated earnings rose to $5.3 million. The return to core earning profitability stems mainly from stabilized credit quality and real estate valuations and the effect on the calculated reserve for loan losses. There has been no provision for loan losses made since the first quarter of 2012 and at March 31, 2013, there was a little more than $200,000 of unallocated reserves stemming from improvement in macro-economic factors as well as decreases to the Bank’s 36 month historical loss calculation. The unallocated reserves are not specific to any particular portfolio segment.

 

In spite of the improved financial outcome for the last several quarters, the Company’s significant consolidated losses from 2007 through 2011 eroded capital and reduced regulatory capital ratios. As a result, the Bank was deemed undercapitalized according to regulatory capital standards beginning December 31, 2010. At that time, the Bank had a total risk-based capital ratio of 7.06%. Earnings recorded by the Bank along with a significant reduction in risk-weighted assets during 2012 improved the total risk-based capital ratio to 7.88% at December 31, 2012. At March 31, 2013, the Bank’s total risk-based capital ratio advanced to 8.04% as a result of the Bank’s first quarter earnings and a $25,000 capital contribution from the Company. The Bank is now considered adequately capitalized according to regulatory capital standards.

 

From 2007 through 2011 when the Company recorded significant losses primarily as a result of deteriorating asset quality, 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 Department of Insurance and Financial Services (“DIFS”) previously the 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 DIFS. 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 remained out of compliance with the Consent Order as of March 31, 2013.

 

-9-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

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 limited resources with which to assist the Bank in achieving the capital level required by the Consent Order. The Company’s main liquidity resource is its cash account balance which, as of March 31, 2013, was approximately $745,000.

 

On January 3, 2011, the Company was not able to repay its $5 million term loan owed to Fifth Third Bank (“Fifth Third”); nor was the Company able to make the proceeding ten quarterly interest payments. The term loan was in default for 25 months. At December 31, 2012, the total amount owed Fifth Third was $5,763,000. On March 20, 2013, the Company, with approval from the FRB, borrowed $1,280,000 from 1030 Norton LLC, a Michigan limited liability company owned by nine individuals; three directors of the Company, one former director and five local businessmen, and settled its debt with Fifth Third for $500,000. Settling the Fifth Third debt resulted in a gain of approximately $5.3 million in the first quarter of 2013. As a result of this transaction, the Company was able to achieve positive shareholders’ equity of approximately $4 million at March 31, 2013.

 

In addition to the payment to Fifth Third, the proceeds of the new senior debt will be used for interest carry, general operations and potential capital support for the Bank. The note bears interest at 8% per annum until paid in full. Interest is payable quarterly in arrears. The note matures on March 31, 2015 and is secured by all of the issued and outstanding shares of the Bank as evidenced by a pledge agreement between the Company and 1030 Norton LLC dated March 20, 2013. The reduced amount of borrowings is expected to decrease interest expense by approximately $200,000 annually. Refer to Note 11 for further discussion.

 

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.

 

-10-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

During the 60 days, the board made efforts to secure funding and comply with the Directive but was not successful. Through several quarters of earnings and a $25,000 capital contribution from the Company, the Bank reached an adequately capitalized regulatory capital category at March 31, 2013. Achievement of the capital level stipulated in the Directive was formally communicated to the FDIC through the submission of the quarterly Call Report as well as the quarterly written communication both submitted by management at the end of April.

 

Regardless of meeting the stipulations in the Directive, failure to comply with the provisions of the Consent Order or the Written Agreement may subject the Bank to further regulatory enforcement action.

 

The Company’s extended period of net losses, failure to repay its term loan at maturity, timely 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, 2012, 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.

 

2.SECURITIES AVAILABLE FOR SALE:

 

The following tables represent the securities held in the Company’s portfolio at March 31, 2013 and at December 31, 2012:

 

       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
March 31, 2013  Cost   Gains   Losses   Value 
                 
US Treasury  $3,039,590   $46,426   $0   $3,086,016 
US Government and federal agency   18,964,298    228,567    (5,235)   19,187,630 
Municipals   2,258,474    62,612    0    2,321,086 
Mortgage-backed and collateralized mortgage obligations– residential   13,660,752    232,931    (39,835)   13,853,848 
   $37,923,114   $570,536   $(45,070)  $38,448,580 

 

       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
December 31, 2012  Cost   Gains   Losses   Value 
                 
US Treasury  $4,044,909   $49,623   $0   $4,094,532 
US Government and federal agency   20,013,843    250,523    (4,623)   20,259,743 
Municipals   2,260,272    73,469    0    2,333,741 
Mortgage-backed and collateralized mortgage obligations– residential   14,539,668    264,090    (31,378)   14,772,380 
   $40,858,692   $637,705   $(36,001)  $41,460,396 

 

-11-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

2.SECURITIES AVAILABLE FOR SALE (Continued):

 

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 March 31, 2013:

 

   Amortized   Fair 
   Cost   Value 
Due in one year or less  $5,523,671   $5,578,947 
Due from one to five years   17,676,287    17,906,076 
Due from five to ten years   1,062,404    1,109,709 
Due in more than ten years   0    0 
Mortgage-backed and collateralized mortgage obligations – residential   13,660,752    13,853,848 
   $37,923,114   $38,448,580 

 

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 March 31, 2013 and December 31, 2012:

 

   Less than 12 Months   12 Months or Longer   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
March 31, 2013  Value   Losses   Value   Losses   Value   Losses 
US Government and federal agency  $2,044,127   $(5,235)  $0   $ 0   $2,044,127   $(5,235)
Mortgage-backed and collateralized mortgage obligations - residential   6,342,046    (38,998)   248,609    (837)   6,590,655    (39,835)
   $8,386,173   $(44,233)  $248,609   $(837)  $8,634,782   $(45,070)

 

   Less than 12 Months   12 Months or Longer   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
December 31, 2012  Value   Losses   Value   Losses   Value   Losses 
US Government and federal agency  $3,050,187   $(4,623)  $0   $0   $3,050,187   $(4,623)
Mortgage-backed and collateralized mortgage obligations - residential   3,882,818    (21,580)   269,692    (9,798)   4,152,510    (31,378)
   $6,933,005   $(26,203)  $269,692   $(9,798)  $7,202,697   $(36,001)

 

No securities were sold in the three months ended March 31, 2013. There was one security sold in the first three 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. In the first three months of 2013, there were no transfers out of accumulated other comprehensive income for loan sales.

 

-12-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

2.SECURITIES AVAILABLE FOR SALE (Continued):

 

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 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 March 31, 2013, all of the mortgage-backed securities and collateralized mortgage obligations held by the Company were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae, Freddie Mac and Ginnie Mae, institutions which the government has affirmed its commitment to support. At March 31, 2013, eleven debt securities had unrealized losses with aggregate depreciation of 0.52% from the amortized cost basis. Five of the eleven securities are issued by government agencies and six are issued by a government-sponsored entity. It is likely that these 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 March 31, 2013.

 

-13-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

3.LOANS

 

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

 

   March 31, 2013   December 31, 2012 
Commercial  $42,433,661   $39,915,144 
Commercial Real Estate:          
General   54,300,500    53,096,828 
Construction   2,283,357    3,464,366 
Consumer:          
Lines of credit   8,805,290    9,105,387 
Other   1,844,773    2,015,234 
Credit card   487,350    490,802 
Residential   16,220,753    17,798,131 
Net deferred loan fees   (55,086)   (55,642)
    126,320,598    125,830,250 
Less: Allowance for loan losses   (3,302,297)   (3,382,977)
Loans, net  $123,018,301   $122,447,273 

 

-14-
 

 

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 ended March 31, 2013 and 2012 by portfolio segment:

 

Three Months Ended March 31, 2013  Commercial   Commercial
Real Estate
   Consumer   Residential   Unallocated   Total 
Allowance for loan losses:                              
Beginning balance  $582,198   $2,266,302   $331,459   $203,018   $0   $3,382,977 
Charge-offs   (40,253)   (9,711)   (18,291)   (54,599)   0    (122,854)
Recoveries   39,584    0    2,590    0    0    42,174 
Provision for loan losses   (57,146)   (183,835)   14,270    21,130    205,581    0 
Ending balance  $524,383   $2,072,756   $330,028   $169,549   $205,581   $3,302,297 

 

Three Months Ended March 31, 2012  Commercial   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   (188,792)   (762,700)   (14,788)   0    0    (966,280)
Recoveries   8,109    0    17,785    0    0    25,894 
Provision for loan losses   9,114    (137,025)   100,262    12,613    90,071    75,035 
Ending balance  $1,138,063   $2,486,708   $513,260   $206,001   $90,071   $4,434,103 

 

-15-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

The remaining loan footnote tables on the following pages present loans at the recorded investment which includes unpaid principal, accrued interest receivable and net deferred, unearned fees. 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 March 31, 2013 and December 31, 2012:

 

March 31, 2013  Commercial   Commercial
Real Estate
   Consumer   Residential   Unallocated   Total 
Allowance for loan losses:                              
Ending allowance balance attributable to loans:                              
Individually evaluated for impairment  $36,168   $1,365,307   $111,767   $86,507   $0   $1,599,749 
Collectively evaluated for impairment   488,215    707,449    218,261    83,042    0    1,496,967 
Unallocated   0    0    0    0    205,581    205,581 
Total ending allowance balance  $524,383   $2,072,756   $330,028   $169,549   $205,581   $3,302,297 
                               
Loans:                              
Individually evaluated for impairment  $1,458,810   $6,884,619   $292,757   $583,288   $0   $9,219,474 
Collectively evaluated for impairment   41,101,283    49,828,691    10,885,245    15,682,434    0    117,497,653 
Total ending loans balance  $42,560,093   $56,713,310   $11,178,002   $16,265,722   $0   $126,717,127 

 

December 31, 2012  Commercial   Commercial
Real Estate
   Consumer   Residential   Unallocated   Total 
Allowance for loan losses:                              
Ending allowance balance attributable to loans:                              
Individually evaluated for impairment  $104,727   $1,489,569   $89,050   $127,030   $0   $1,810,376 
Collectively evaluated for impairment   477,471    776,733    242,409    75,988    0    1,572,601 
Unallocated   0    0    0    0    0    0 
Total ending allowance balance  $582,198   $2,266,302   $331,459   $203,018   $0   $3,382,977 
                               
Loans:                              
Individually evaluated for impairment  $3,288,294   $7,322,850   $321,820   $782,732   $0   $11,715,696 
Collectively evaluated for impairment   36,739,269    49,391,498    11,329,495    17,063,417    0    114,523,679 
Total ending loans balance  $40,027,563   $56,714,348   $11,651,315   $17,846,149   $0   $126,239,375 

 

-16-
 

 

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 March 31, 2013 and December 31, 2012. For purposes of this disclosure, the unpaid principal balance is not reduced for partial charge-offs.

 

               Three Months   Three Months   Three Months 
   Recorded   Unpaid Principal   Related   Average Recorded   Interest Income   Cash Basis 
March 31, 2013  Investment   Balance   Allowance   Investment   Recognized   Interest Recognized 
With no related allowance recorded:                              
Commercial  $1,352,118   $1,472,359   $0   $1,912,112   $13,394   $12,981 
Commercial Real Estate:                              
General   2,332,622    2,397,940    0    2,468,797    26,115    26,115 
Construction   0    0    0    0    0    0 
Consumer:                              
Lines of credit   76,906    76,846    0    109,721    292    292 
Other   30,495    30,495    0    23,605    0    0 
Credit card   0    0    0    0    0    0 
Residential   124,336    157,001    0    158,018    0    0 
Subtotal  $3,916,477   $4,134,641   $0   $4,672,253   $39,801   $39,388 
                               
With an allowance recorded:                              
Commercial  $106,692   $106,656   $36,168   $733,604   $9,614   $9,257 
Commercial Real Estate:                              
General   4,551,997    4,563,541    1,365,307    4,511,715    31,111    31,111 
Construction   0    0    0    0    0    0 
Consumer:                              
Lines of credit   68,638    68,541    67,930    118,341    954    774 
Other   114,028    113,869    41,147    107,710    470    470 
Credit card   2,690    2,690    2,690    897    0    0 
Residential   458,952    467,010    86,507    470,185    4,804    4,223 
Subtotal  $5,302,997   $5,322,307   $1,599,749   $5,942,452   $46,953   $45,835 
Total  $9,219,474   $9,456,948   $1,599,749   $10,614,705   $86,754   $85,223 

 

-17-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

               Twelve Months   Twelve Months   Twelve Months 
   Recorded   Unpaid Principal   Related   Average Recorded   Interest Income   Cash Basis 
December 31, 2012  Investment   Balance   Allowance   Investment   Recognized   Interest Recognized 
With no related allowance recorded:                              
Commercial  $2,147,075   $2,295,401   $0   $2,413,625   $66,634   $56,123 
Commercial Real Estate:                              
General   2,662,984    2,739,027    0    2,783,388    66,501    64,093 
Construction   0    0    0    167,274    0    0 
Consumer:                              
Lines of credit   55,659    55,524    0    46,916    9,177    5,228 
Other   26,221    26,221    0    17,290    106    0 
Credit card   0    0    0    0    0    0 
Residential   208,178    240,491    0    285,420    345    340 
Subtotal  $5,100,117   $5,356,664   $0   $5,713,913   $142,763   $125,784 
With an allowance recorded:                              
Commercial  $1,141,219   $1,139,885   $104,727   $1,510,788   $65,446   $38,083 
Commercial Real Estate:                              
General   4,659,866    4,675,981    1,489,569    5,228,456    142,583    112,299 
Construction   0    0    0    21,201    0    0 
Consumer:                              
Lines of credit   135,111    134,976    40,180    176,507    3,897    3,431 
Other   104,829    104,664    48,870    114,664    2,048    1,923 
Credit card   0    0    0    988    0    0 
Residential   574,554    594,307    127,030    486,301    12,907    12,541 
Subtotal  $6,615,579   $6,649,813   $1,810,376   $7,538,905   $226,881   $168,277 
Total  $11,715,696   $12,006,477   $1,810,376   $13,252,818   $369,644   $294,061 

 

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.

 

-18-
 

 

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 March 31, 2013:

 

           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  $1,087   $0   $0   $1,087   $42,175,615   $42,176,702 
Commercial Real Estate:                              
General   0    0    0    0    51,811,680    51,811,680 
Construction   0    0    0    0    2,290,947    2,290,947 
Consumer:                              
Lines of credit   71,480    0    0    71,480    8,610,706    8,682,186 
Other   0    3,370    0    3,370    1,829,610    1,832,980 
Credit card   3,559    0    0    3,559    483,791    487,350 
Residential   0    79,700    0    79,700    16,080,540    16,160,240 
Total  $76,126   $83,070   $0   $159,196   $123,282,889   $123,442,085 

 

           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   $135,404   $135,404   $247,987   $383,391 
Commercial Real Estate:                              
General   0    0    405,742    405,742    2,204,941    2,610,683 
Construction   0    0    0    0    0    0 
Consumer:                              
Lines of credit   0    0    19,429    19,429    135,934    155,363 
Other   6,999    0    13,124    20,123    0    20,123 
Credit card   0    0    0    0    0    0 
Residential   0    0    0    0    105,482    105,482 
Total  $6,999   $0   $573,699   $580,698   $2,694,344   $3,275,042 

 

-19-
 

 

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, 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  $1,956   $0   $0   $1,956   $39,465,435   $39,467,391 
Commercial Real Estate:                              
General   97,605    0    0    97,605    50,193,607    50,291,212 
Construction   0    0    0    0    3,479,043    3,479,043 
Consumer:                              
Lines of credit   26,037    44,866    0    70,903    8,963,308    9,034,211 
Other   3,707    0    0    3,707    2,015,334    2,019,041 
Credit card   2,010    0    0    2,010    488,792    490,802 
Residential   0    85,242    0    85,242    17,456,776    17,542,018 
Total  $131,315   $130,108   $0   $261,423   $122,062,295   $122,323,718 

 

           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  $8,958   $20,469   $320,592   $350,019   $210,153   $560,172 
Commercial Real Estate:                              
General   8,414    280,399    406,792    695,605    2,248,488    2,944,093 
Construction   0    0    0    0    0    0 
Consumer:                              
Lines of credit   0    21,583    0    21,583    79,628    101,211 
Other   0    0    6,050    6,050    0    6,050 
Credit card   0    0    0    0    0    0 
Residential   0    0    195,649    195,649    108,482    304,131 
Total  $17,372   $322,451   $929,083   $1,268,906   $2,646,751   $3,915,657 

 

-20-
 

 

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 $1,542,741 of specific reserves on $8,435,539 of unpaid principal balance of loans to customers whose loan terms have been modified in troubled debt restructurings as of March 31, 2013 and $1,699,851 on $10,441,218 of unpaid principal balance of loans as of December 31, 2012. At March 31, 2013, the Company had an additional $60,923 in performing loans outstanding to one of those customers. As of December 31, 2012, there was $184,364 committed to one customer.

 

During the three month periods ended March 31, 2013 and 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; financing concessions; or a permanent reduction of the recorded investment in the loan.

 

One A-B note modification involved a permanent reduction of the recorded investment in the loan.

 

The following table presents loans by class modified as troubled debt restructurings that occurred during the three month period ended March 31, 2013:

 

       Pre-Modification   Post-Modification 
       Outstanding Recorded   Outstanding Recorded 
Three Months Ended March 31, 2013  Number of Loans   Investment   Investment 
Troubled Debt Restructurings:               
Commercial   1   $143,136   $133,425 
Total   1   $143,136   $133,425 

 

In the three month period ended March 31, 2013, there were $9,700 of charge-offs related to the A-B note modification. As of March 31, 2013, there were no specific reserves on the remaining balance of this troubled debt restructuring.

 

-21-
 

 

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 three month period ended March 31, 2012:

 

       Pre-Modification   Post-Modification 
       Outstanding Recorded   Outstanding Recorded 
Three Months Ended March 31, 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   1    104,444    104,444 
Residential   1    62,085    62,085 
Total   8   $3,624,678   $2,986,555 

 

In the three month period ended March 31, 2012, there were $638,000 of charge-offs as part of a troubled debt restructuring arrangement and an additional $30,000 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 month periods ended March 31, 2013 and 2012, there were no troubled debt restructurings that experienced a payment default within 12 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.

 

-22-
 

 

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 a 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.

 

-23-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

As of March 31, 2013 and December 31, 2012, and based on the most recent analysis performed, the recorded investment by risk category and class of loans is as follows:

 

       Commercial Real Estate   Commercial Real Estate 
   Commercial   General   Construction 
   March 31,   December 31,   March 31,   December 31,   March 31,   December 31, 
   2013   2012   2013   2012   2013   2012 
1  $0   $0   $0   $0   $0   $0 
2   253,151    298,200    0    0    0    0 
3   2,558,219    2,004,476    4,017,191    4,141,391    0    0 
4   14,419,073    14,017,221    13,618,010    12,911,811    318,587    384,848 
5   17,908,163    16,373,423    23,013,046    22,177,734    574,508    1,695,990 
5M   4,574,018    3,318,016    3,539,004    3,675,131    1,397,852    1,398,205 
6   1,389,134    2,180,119    7,655,893    7,365,970    0    0 
7   1,298,786    1,369,803    0    287,682    0    0 
8   159,549    466,305    2,579,219    2,675,586    0    0 
Total  $42,560,093   $40,027,563   $54,422,363   $53,235,305   $2,290,947   $3,479,043 

 

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 March 31, 2013 and December 31, 2012:

 

   Residential 
   March 31,   December 31, 
   2013   2012 
Performing  $15,682,434   $17,063,417 
Impaired   583,288    782,732 
Total  $16,265,722   $17,846,149 

 

   Consumer – Lines of credit   Consumer – Other   Consumer – Credit card 
   March 31,   December 31,   March 31,   December 31,   March 31,   December 31, 
   2013   2012   2013   2012   2013   2012 
Performing  $8,692,005   $8,944,652   $1,708,580   $1,894,041   $484,660   $490,802 
Impaired   145,544    190,770    144,523    131,050    2,690    0 
Total  $8,837,549   $9,135,422   $1,853,103   $2,025,091   $487,350   $490,802 

 

-24-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

5.FORECLOSED ASSETS

 

Foreclosed asset activity:

 

   March 31,   March 31, 
   2013   2012 
Beginning of year  $2,806,781   $3,276,838 
Additions   380,749    298,628 
Reductions from sales   (81,399)   (391,679)
Direct write-downs   (7,599)   (91,142)
End of period  $3,098,532   $3,092,645 
           
Expenses related to foreclosed assets include:          
Operating expenses, net of rental income  $87,838   $83,248 

 

6.PREMISES AND EQUIPMENT

 

Period end premises and equipment were as follows:

 

   March 31,   December 31, 
   2013   2012 
Land & land improvements  $4,700,464   $4,700,464 
Buildings & building improvements   6,144,749    6,132,163 
Furniture, fixtures and equipment   3,829,645    3,800,460 
    14,674,858    14,633,087 
Less: accumulated depreciation   5,312,843    5,212,201 
   $9,362,015   $9,420,886 

 

-25-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

7.DEPOSITS

 

The components of the outstanding deposit balances at March 31, 2013 and December 31, 2012 were as follows:

 

   March 31,   December 31, 
   2013   2012 
Non-interest-bearing DDA  $31,966,192   $40,271,190 
Interest-bearing DDA   26,247,580    22,865,704 
Money market   27,103,974    18,602,302 
Savings   8,561,554    9,018,387 
Time, under $100,000   80,233,437    83,416,175 
Time, over $100,000   9,784,448    10,002,735 
Total Deposits  $183,897,185   $184,176,493 

 

There were no brokered deposits at March 31, 2013 and December 31, 2012. Since the Bank was not categorized as “well capitalized” at March 31, 2013 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 March 31, 2013 and December 31, 2012 short-term borrowing information was as follows:

 

   Repurchase 
   Agreements 
     
Outstanding at March 31, 2013  $10,174,229 
Average interest rate at period end   0.60%
Average balance during period   10,117,007 
Average interest rate during period   0.60%
Maximum month end balance during period   10,878,256 
      
Outstanding at December 31, 2012  $10,190,059 
Average interest rate at year-end   0.59%
Average balance during year   9,241,260 
Average interest rate during year   0.75%
Maximum month end balance during year   12,037,087 

 

-26-
 

 

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 (“FHLB”) of Indianapolis. Based on its current FHLB stock holdings and collateral, the Bank has the capacity to borrow $3,144,864. Each borrowing requires a direct pledge of securities and or loans. To support potential borrowings with the FHLB, the Bank had residential loans with a fair market value of $3,931,080 pledged at March 31, 2013. The Bank had no outstanding borrowings with the FHLB at either March 31, 2013 or December 31, 2012.

 

10.SUBORDINATED DEBENTURES

 

The Trust, as defined in Note 1, 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 2.33% at March 31, 2013 and 2.36% at December 31, 2012. The stated maturity is December 30, 2034. The trust preferred securities are redeemable at par value on any interest payment date and are, in effect, guaranteed by the Company. Interest on the subordinated debentures is payable quarterly on March 30th, June 30th, September 30th and December 30th. The Company is not considered the primary beneficiary of the Trust (under the variable interest entity rules), 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 become immediately due and payable.

 

The indenture under which the subordinated debentures were issued prohibits certain actions by the Company during the deferral period. Among other things, during the deferral period and subject to certain exceptions, 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 March 31, 2013, the accrued interest payable on the subordinated debentures was $355,215.

 

-27-
 

 

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 Company did not have the resources to pay the amount due. The loan was in default at year-end 2012. In addition to the outstanding principal due, there was accrued interest of $763,000 at December 31, 2012. The outstanding principal had an interest rate of 6.00% per annum; 275 basis points above Fifth Third’s prime rate.

 

On March 20, 2013, the Company, with approval from the FRB, borrowed $1,280,000 from 1030 Norton LLC, a Michigan limited liability company owned by nine individuals; three directors of the Company, one former director and five local businessmen, and settled its debt in full with Fifth Third for $500,000. In addition to the payment to Fifth Third, the proceeds of the new senior debt will be used for interest carry, general operations and potential capital support for the Bank. The note bears interest at a fixed rate of 8.00% per annum until paid in full. Interest is payable quarterly, in arrears. The note matures on March 31, 2015. The note is secured by a pledge of all of the issued and outstanding shares of the Bank as evidenced by a pledge agreement between the Company and 1030 Norton LLC. The accrued interest at March 31, 2013 was approximately $3,000. The entire interest balance due was paid on April 1, 2013.

 

Settling the Fifth Third debt resulted in a gain of approximately $5.3 million in the first quarter of 2013. As a result of this transaction, the Company was able to achieve positive shareholders’ equity of approximately $4 million at March 31, 2013.

 

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 March 31, 2013 and December 31, 2012 follows:

 

   March 31, 2013   December 31, 2012 
         
Unused lines of credit and letters of credit  $21,475,446   $22,817,615 
Commitments to make loans   374,002    253,000 

 

Commitments to make loans generally terminate one year or less from the date of commitment and may require a fee. Since many of the above commitments 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.

 

-28-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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.

 

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. The 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 method used to determine the valuation of impaired loans depends on the anticipated source of repayment. Collateral dependent impaired loans with specific allocations of the allowance for loan losses are measured using the fair value of the collateral which 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.

 

-29-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

13.FAIR VALUE MEASUREMENTS (Continued)

 

Non-real estate collateral may be valued using appraisals, independent valuation tools, net book value per the borrower’s financial statements, or aging reports.  To determine the fair value, these values are adjusted or discounted based on several factors, including but not limited to: the Bank’s historical losses within that particular asset category;  knowledge of the collateral, including age and condition; and  changes in market conditions from the time of the valuation,  resulting in a Level 3 fair value classification.  Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

 

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.

 

-30-
 

 

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 March 31, 2013 and December 31, 2012:

 

       Fair Value Measurements Using 
       Quoted Prices   Significant     
       in Active   Other   Significant 
       Markets for   Observable   Unobservable 
       Identical Assets   Inputs   Inputs 
March 31, 2013  Total   (Level 1)   (Level 2)   (Level 3) 
Available for sale securities:                    
US Treasury  $3,086,016   $3,086,016   $0   $0 
US Government and federal agency   19,187,630    0    19,187,630    0 
Municipals   2,321,086    0    2,321,086    0 
Mortgage-backed and collateralized mortgage obligations– residential   13,853,848    0    13,853,848    0 
Total  $38,448,580   $3,086,016   $35,362,564   $0 
                     
Servicing assets  $40,741   $0   $40,741   $0 
                     
December 31, 2012                    
Available for sale securities:                    
US Treasury  $4,094,532   $4,094,532   $0   $0 
US Government and federal agency   20,259,743    0    20,259,743    0 
Municipals   2,333,741    0    2,333,741    0 
Mortgage-backed and collateralized mortgage obligations– residential   14,772,380    0    14,772,380    0 
Total  $41,460,396   $4,094,532   $37,365,864   $0 
                     
Servicing assets  $41,650   $0   $41,650   $0 

 

There were no transfers between levels during the first quarters of 2013 or 2012.

 

-31-
 

 

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 March 31, 2013 and December 31, 2012. 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) 
March 31, 2013          
Impaired loans:          
Commercial  $132,798   $132,798 
Commercial Real Estate:          
General   851,530    851,530 
Consumer:          
Lines of credit   42    42 
Other   22,561    22,561 
Residential   68,590    68,590 
Total  $1,075,521   $1,075,521 
Foreclosed assets:          
Commercial Real Estate:          
General  $737,294   $737,294 
Residential   154,250    154,250 
Total  $891,544   $891,544 
           
December 31, 2012          
Impaired loans:          
Commercial  $84,755   $84,755 
Commercial Real Estate:          
General   786,282    786,282 
Residential   140,269    140,269 
Total  $1,011,306   $1,011,306 
Foreclosed assets:          
Commercial Real Estate:          
General  $141,596   $141,596 
Construction   380,142    380,142 
Total  $521,738   $521,738 

 

-32-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

13.FAIR VALUE MEASUREMENTS (Continued)

 

The following describes the impairment charges recognized during the period:

 

At March 31, 2013, impaired loans carried at fair value had a recorded investment of $2,316,212 and a valuation allowance of $1,240,691, resulting in additional provision of $10,000. At December 31, 2012, impaired loans carried at fair value had a recorded investment of $2,394,211 and a valuation allowance of $1,382,905, resulting in additional provision of $13,000.

 

Foreclosed assets carried at fair value at March 31, 2013 were $891,544 compared to $521,738 at December 31, 2012. During 2013, three properties included in this total were written down by $7,599. During 2012, three properties included in this total were written down by $128,139.

 

-33-
 

  

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

13.FAIR VALUE MEASUREMENTS (Continued)

 

The following tables present information as of March 31, 2013 and December 31, 2012 about significant unobservable inputs related to the Bank’s individually material1 Level 3 financial assets, by class, measured on a non-recurring basis:

 

       Valuation  Significant Unobservable  Range   Weighted 
   Fair Value   Technique (s)  Inputs  of Inputs   Average 
March 31, 2013                     
                      
Impaired loans:          Adjustments for differences between          
Commercial Real Estate:       Sales comparison approach  the comparable sales   0%   0%
General  $851,530   Income approach  Capitalization rate   10.0%   10.0%
Total  $851,530                 
Foreclosed assets:          Adjustments for differences between          
Commercial Real Estate:       Sales comparison approach  the comparable sales   (16.8) - 16.0%   1.3%
General  $503,595   Income approach  Capitalization rate   10.0%   10.0%
           Adjustments for differences in net          
        Income approach  operating income expectations   (64.0) - 28.6%   (7.7)%
Total  $503,595                 

 

       Valuation  Significant Unobservable  Range   Weighted 
   Fair Value   Technique (s)  Inputs  of Inputs   Average 
December 31, 2012                     
                      
Impaired loans:          Adjustments for differences between          
Commercial Real Estate:       Sales comparison approach  the comparable sales   0%   0%
General  $698,475   Income approach  Capitalization rate   10.0%   10.0%
Total  $698,475                 
Foreclosed assets:                     
Commercial Real Estate:          Adjustments for differences between          
Construction  $269,100   Sales comparison approach  the comparable sales   (45.0) - 0%   (4.5)%
Total  $269,100                 

 

 

1For purposes of this disclosure, only material Level 3 assets are disclosed. These assets are included in the total non-recurring Level 3 financial assets reported in the preceding tables.

 

-34-
 

 

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 
       at March 31, 2013 Using 
   Carrying                 
   Amount   Level 1   Level 2   Level 3   Total 
   (in thousands) 
Financial assets                         
Cash and cash equivalents  $23,512   $23,512   $0   $0   $23,512 
Loans held for sale   5,271    0    5,367    0    5,367 
Loans, net (including impaired)   123,018    0    0    115,738    115,738 
FHLB stock   451    N/A    N/A    N/A    N/A 
Accrued interest receivable   584    15    168    401    584 
                          
Financial liabilities                         
Deposits   183,897    90,848    90,717    0    181,565 
Federal funds purchased and repurchase agreements   10,174    0    10,174    0    10,174 
Subordinated debentures   4,500    0    0    1,125    1,125 
Notes payable   1,280    0    0    1,280    1,280 
Accrued interest payable   408    5    45    92    142 

 

       Fair Value Measurements 
       at December 31, 2012 Using 
   Carrying                 
   Amount   Level 1   Level 2   Level 3   Total 
   (in thousands) 
Financial assets                         
Cash and cash equivalents  $20,297   $20,297   $0   $0   $20,297 
Loans held for sale   6,041    0    6,183    0    6,183 
Loans, net (including impaired)   122,447    0    0    116,004    116,004 
FHLB stock   451    N/A    N/A    N/A    N/A 
Accrued interest receivable   592    12    163    417    592 
                          
Financial liabilities                         
Deposits   184,176    88,959    94,185    0    183,144 
Federal funds purchased and repurchase agreements   10,190    0    10,190    0    10,190 
Subordinated debentures   4,500    0    0    1,125    1,125 
Notes payable   5,000    0    0    500    500 
Accrued interest payable   1,156    4    64    81    149 

 

-35-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

13.FAIR VALUE MEASUREMENTS (Continued)

 

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.

 

(d) Deposits

 

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, 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.

 

-36-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

13.FAIR VALUE MEASUREMENTS (Continued)

 

(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 2007 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.

 

Although the Company recognized a profit in 2012 and the first quarter of 2013, there must be a consistent trend of profitability in order to support the realization of our deferred tax assets. 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.

 

As a result of the large gain on the extinguishment of debt, the Company recorded income tax expense from operations in the amount of $105,000. This amount represents projected taxable earnings subject to alternative minimum taxation which may fluctuate throughout the year with changes in operating results. Additionally, the gain on the extinguishment of debt may result in a reduction of net operating loss carry forward tax attributes by an estimated $5.3 million.  Even so, the Company’s estimated net operating loss carry forward remaining would be over $6 million.

 

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.

 

-37-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

15.REGULATORY MATTERS (Continued)

 

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 December 31, 2012. At March 31, 2013, through earnings and a $25,000 capital contribution from the Company, the Bank achieved a total risk-based capital ratio of 8.04%; four basis points above the required level to be in the adequately capitalized regulatory category.

 

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 March 31, 2013 and December 31, 2012 were:

 

           Minimum Required   Minimum Required 
           For Capital   Under 
   Actual   Adequacy Purposes   Consent Order 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
                         
March 31, 2013                              
Total Capital (Tier 1 and Tier 2) to risk-weighted assets of the Bank  $11,012,275    8.04%  $10,959,282    8.00%  $15,069,013    11.00%
Tier 1 (Core) Capital to risk-weighted assets of the Bank   9,280,259    6.77    5,479,641    4.00    N/A    N/A 
Tier 1 (Core) Capital to average assets of the Bank   9,280,259    4.57    8,122,318    4.00    17,259,925    8.50 

 

           Minimum Required   Minimum Required 
           For Capital   Under 
   Actual   Adequacy Purposes   Consent Order 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
                         
December 31, 2012                              
Total Capital (Tier 1 and Tier 2) to risk-weighted assets of the Bank  $10,760,348    7.88%  $10,928,836    8.00%  $15,027,149    11.00%
Tier 1 (Core) Capital to risk-weighted assets of the Bank   9,032,034    6.61    5,464,418    4.00    N/A    N/A 
Tier 1 (Core) Capital to average assets of the Bank   9,032,034    4.53    7,976,194    4.00    16,949,413    8.50 

 

-38-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

15.REGULATORY MATTERS (Continued)

 

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 March 31, 2013, only $1,732,016 was counted as Tier 2 capital and $1,570,281 was disallowed. At December 31, 2012, $1,728,314 was counted as Tier 2 capital and $1,654,663 was disallowed.

 

The Bank’s Consent Order with the FDIC and the DIFS, 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 DIFS.

 

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 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 March 31, 2013 or either December 31, 2010, 2011 or 2012. Management continues to explore options to raise the capital required for full compliance. At March 31, 2013, a capital contribution of $7,980,000 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.

 

-39-
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

15.REGULATORY MATTERS (Continued)

 

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. The liquidity plan was meant to address the stipulation in the Consent Order that prohibited the Bank from accepting brokered deposits. To meet this restriction, the Bank’s liquidity plan entailed replacing maturing brokered deposits with a combination of local deposits and internet based time deposits. Since the beginning of 2010, the Bank has successfully used this strategy. There were no brokered deposits outstanding at March 31, 2013. The Bank has been able to maintain sufficient liquidity for its required payments despite the restriction on issuing brokered deposits.

 

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. Through several quarters of earnings and a $25,000 capital contribution from the Company, the Bank reached an adequately capitalized regulatory capital category at March 31, 2013. Achievement of the capital level stipulated in the Directive was formally communicated to the FDIC through the submission of the quarterly Call Report as well as the required quarterly written communication both submitted by management at the end of April.

 

-40-
 

 

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 March 31, 2013 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 March 31, 2013 to that at December 31, 2012. The part labeled Results of Operations discusses the three month period ending March 31, 2013 as compared to the same period of 2012. 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 Annual Report contain forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about the Company, the Bank, the Mortgage Company, 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; 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.

 

-41-
 

 

COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

The overall economic environment remains challenging particularly from an interest rate standpoint, but other economic indicators appear to be stabilizing, both nationally and locally. Unemployment in both Muskegon and Ottawa counties is declining but nonetheless remains at an elevated level. At March 31, 2013, unemployment was 8.4% for Muskegon County and 6.2% for Ottawa County which compares favorably to unemployment rates of 8.7% for Muskegon County and 7.1% for Ottawa County at March 31, 2012. Additionally, property values, although low, are holding. Stable property values are likely to lead to more real estate sales and construction activity. However, in spite of the improvements in the economic climate, the effects of the extended downturn had an adverse effect on the financial health of the Bank. Poor earnings stemming primarily from deteriorating asset quality eroded the Bank’s capital and corresponding regulatory capital ratios subjecting it to additional regulatory scrutiny.

 

On September 2, 2010, the Bank entered into a Consent Order with the FDIC and the State of Michigan’s DIFS, 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 DIFS. 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 remained out of compliance with the Consent Order as of March 31, 2013.

 

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 limited resources with which to assist the Bank in achieving the capital level required by the Consent Order. The Company’s main liquidity resource is its cash account balance which, as of March 31, 2013, was approximately $745,000 compared to just $8,000 at year-end 2012. The increase in cash resulted from the issuance of senior debt during the first quarter of 2013.

 

-42-
 

 

COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

On January 3, 2011, the Company was not able to repay its $5 million term loan owed to Fifth Third Bank; nor was the Company able to make the proceeding ten quarterly interest payments. The term loan was in default for 25 months. At December 31, 2012, the total amount owed Fifth Third was $5,763,000. On March 20, 2013, the Company, with approval from the FRB, borrowed $1,280,000 from 1030 Norton LLC, a Michigan limited liability company owned by nine individuals; three directors of the Company, one former director and five local businessmen, and settled its debt with Fifth Third for $500,000. In addition to the payment to Fifth Third, the proceeds of the new senior debt will be used for interest carry, general operations and potential capital support for the Bank. The note bears interest at 8% per annum until paid in full. Interest is payable quarterly in arrears. The note matures on March 31, 2015. The note is secured by all of the issued and outstanding shares of the Bank as evidenced by a pledge agreement between the Company and 1030 Norton LLC dated March 20, 2013. The reduced amount of borrowings is expected to decrease interest expense by approximately $200,000 annually.

 

Settling the Fifth Third debt resulted in a gain of approximately $5.3 million in the first quarter of 2013. As a result of this transaction, the Company was able to achieve positive shareholders’ equity of approximately $4 million at March 31, 2013.

 

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. Through several quarters of earnings and a $25,000 capital contribution from the Company, the Bank reached an adequately capitalized regulatory capital category at March 31, 2013. Achievement of the capital level stipulated in the Directive was formally communicated to the FDIC through the submission of the quarterly Call Report as well as the quarterly written communication both submitted by management at the end of April.

 

Regardless of meeting the stipulations in the Directive, failure to comply with the provisions of the Consent Order or the Written Agreement may subject the Bank to further regulatory enforcement action.

 

The Company’s extended period of net losses, failure to repay its term loan at maturity, timely 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, 2012, 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.

 

-43-
 

 

COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES: The purpose of this section of the Annual Report is to provide a narrative discussion about the Company’s financial condition and results of operations during 2012. The “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as disclosures found elsewhere in the Annual Report are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. One material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses. Actual results could differ from the estimate.

 

Allowance for loan losses. The allowance for loan losses is maintained at a level believed adequate by management to absorb probable incurred losses inherent in the consolidated loan portfolio. Management’s evaluation of the adequacy of the allowance is an estimate based on reviews of individual loans and loan groupings, assessments of the impact of current and anticipated economic conditions on the portfolio and historical loss experience. See the Financial Condition section of Management’s Discussion and Analysis and Notes 1 and 3 to the Company’s consolidated financial statements for additional information.

 

Management believes the accounting estimate related to the allowance for loan losses is a “critical accounting estimate” because (1) the estimate is highly susceptible to change from period to period because of assumptions concerning the changes in the types and volumes of the portfolios and anticipated economic conditions and (2) the impact of recognizing an impairment or loan loss could have a material effect on the Company’s assets reported on the balance sheet as well as its net income. Management has discussed the development of this critical accounting estimate with the Board of Directors and the Audit Committee.

 

Income Taxes. Income taxes are accounted for under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

 

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

 

Net deferred tax assets are recorded to the extent it is believed that they will more likely than not be realized. In making such a determination, all available positive and negative evidence is considered, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In the event it is determined that deferred income tax assets are in excess of their realizable amount, an adjustment to the valuation allowance would be made which would increase the provision for income taxes.

 

-44-
 

 

COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

In determining the possible realization of deferred tax assets, future taxable income from operations exclusive of reversing temporary differences and tax planning strategies that, if necessary, would be implemented to accelerate taxable income into periods in which net operating losses might otherwise expire is considered.

 

Interest and penalties related to unrecognized tax benefits are recognized within the federal income tax expense (benefit) line in the accompanying consolidated statements of income. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheets.

 

Foreclosed Assets. Foreclosed assets are acquired through loan foreclosure or other proceedings and are initially recorded at fair value less estimated selling costs when acquired, establishing a new cost basis. During the time that foreclosed assets are waiting to be sold, there will be occasions that the Bank will need to re-evaluate the individual market values of each asset. 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 estimated fair value of the asset at the end of the reporting period. On a quarterly basis, the Bank’s Credit Department analyzes foreclosed asset values to determine the level at which they should be held on our books.

 

FINANCIAL CONDITION

 

Total assets were $204.7 million at March 31, 2013 compared to $204.2 million at December 31, 2012. There was no material asset growth between year-end 2012 and March 31, 2013, only shifts in categories of assets partially as a result of the conclusion of the FDIC Transaction Account Guarantee Program (“TAG”). TAG provided unlimited deposit insurance for non-interest bearing transaction accounts at all FDIC insured depository institutions. TAG expired at year-end 2012. To prepare for the program’s end, the Bank developed and executed a contingency funding plan in the last two months of 2012 to accommodate assessed exposure to customer withdrawals. The internal plan involved purchasing additional securities for customer pledging and increasing liquidity in the Bank’s FRB account. Management believes that the balance sheet impact related to TAG’s end has now been fully addressed in all material respects.

 

Cash and cash equivalents increased by $3.2 million to $23.5 million at March 31, 2013 from $20.3 million at December 31, 2012. The Bank’s FRB balance increased $4.1 million since year-end 2012 and was $21.4 million on March 31, 2013. The increase in balance is driven largely by securities that matured or were called and were not replaced. Management is working to address the excess liquidity at the FRB. Although excess liquidity is a conservative posture, it is detrimental to earnings. Typically, a balance at the FRB of between $7 and $10 million is enough to cover the liquidity needs of the Bank’s operations as well as provide a comfortable cushion for unexpected needs. To reduce the FRB balance to the targeted level, the excess funds will be used to repay upcoming time deposit maturities.

 

The Bank’s security portfolio was $38.4 million at March 31, 2013 and $41.5 million at December 31, 2012. Investment activity in the first three months of the year consisted of maturities, prepayments and calls totaling $2.8 million. There were no sales or purchases in the first three months of 2013.

 

The securities portfolio is a key source of liquidity for the Bank. Given the Bank’s weakened condition, off-balance-sheet borrowing facilities are significantly limited, forcing the Bank to resort to on-balance-sheet sources.

 

-45-
 

 

COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

Consequently, it remains critical to maintain the unencumbered portion of the Bank’s security portfolio at a level equal to or perhaps above its general internal policy depending on assessed liquidity needs. The level of unpledged securities is regularly monitored and needs are formally assessed monthly. Maintaining an adequate level of pledgeable assets 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. At March 31, 2013, 24% of the investment portfolio was unencumbered. This outcome is down from the 35% unpledged position that existed on December 31, 2012.

 

At March 31, 2013, $29.4 million of securities were pledged to public fund customers, FRB Automated Clearing House (“ACH”) debit activity and customer repurchase agreements.

 

Investment portfolio quality 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 $525,000. Included in this total are unrealized losses of approximately $45,000. At March 31, 2013, there were 11 securities with an amortized cost of $8.7 million having an unrealized loss. One of the 11 had unrealized losses longer than 12 months. At March 31, 2013, 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 Bank 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 portfolio will continue to be reviewed for impairment in accordance with the Bank’s investment policy.

 

To reduce exposure to future loss (both realized and unrealized) the Bank intends to adhere to the diversification principles outlined in the investment policy and limit issuer concentrations. Besides fully guaranteed U.S. government and federal agency securities, there were no holdings of securities of any one issuer in an amount greater than 10% of the Bank’s common stock and surplus at March 31, 2013.

 

Loans held for sale activity during the first three months of 2013 included $3.3 million of loan originations, $994,000 of loans transferred to the held for investment portfolio and $3.1 million of loan sales. The associated gain on the loan sales was $67,000. The loans that were transferred to the held for investment portfolio were Small Business Administration (“SBA”) loans. The transfer was based on management’s re-evaluation of the Bank’s intent to sell these loans in the short-term.

 

Total loans (held for investment) increased $490,000 and were $126.3 million at March 31, 2013 up from $125.8 million at December 31, 2012. There were decreases in nearly every loan category that were more than offset by increases to the commercial loan portfolio. With the increase in commercial loans outstanding, the concentration changed slightly. At March 31, 2013, the concentration of commercial and commercial real estate loans was 78%; up from a level of 77% at year-end 2012. The wholesale focus of the Bank has remained since opening in 1999. Unfortunately, the sustained economic weakness both nationally and locally from 2008 through 2011 affected many borrowers but particularly the borrowers in these two segments. During that time, the credit deterioration of customers in those segments, primarily commercial real estate, increased the overall risk profile of the Bank. As a result, the Bank incurred significant expenses to address the assessed risk which negatively affected the Bank’s earnings and capital.

 

-46-
 

 

COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

Management believes that the economy in the local market has stabilized substantially over the past several quarters. Loan credit quality has improved. Even so, the Bank remains diligent about monitoring its loan portfolio and will continue 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.

 

The Bank has developed a detailed process to estimate credit risk. The process is discussed at length in Note 1 to the Company’s annual 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. The estimation is the result of loan portfolio analysis completed utilizing a detailed methodology prescribed in the Bank’s credit procedures. Management reviews and analyzes the loan portfolio on a regular basis for the purpose of estimating probable incurred credit losses.

 

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 March 31, 2013, the allowance for loan losses totaled $3.3 million. At year-end 2012, the allowance for loan losses was $3.4 million. The reduction in the allowance is the result of net charge-offs of $81,000 recorded in the first three months of 2013. The ratio of allowance to gross loans outstanding decreased to a level of 2.61% at March 31, 2013 compared to 2.69% at year-end 2012. Seventy-one percent of the loan charge-offs occurring in the first quarter of 2013 held specific allocations at year-end 2012.

 

-47-
 

 

COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

The allocation of the allowance at March 31, 2013 and December 31, 2012 was as follows:

 

   March 31, 2013   December 31, 2012 
       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  $524,383    33.6%  $582,198    31.7%
Commercial Real Estate   2,072,756    44.8    2,266,302    45.0 
Consumer   330,028    8.8    331,459    9.2 
Residential   169,549    12.8    203,018    14.1 
Unallocated   205,581    N/A    0    N/A 
Total  $3,302,297    100%  $3,382,977    100%

 

The general component of the allowance for loan losses as a percentage of non-specifically identified loans was 1.27% at March 31, 2013, a decrease of ten basis points from year-end 2012. At year-end 2012, the general component of the allowance for loan losses was 1.37% of total non-specifically identified loans. There are $206,000 of unallocated reserves in the allowance for loan losses stemming from improvement in macro-economic factors as well as decreases to the Bank’s 36 month historical loss calculation. Management feels that the trend of the general component of the allowance for loan losses is in line with improvement in the local economy, local unemployment and the overall improvement in the credit quality of the loan portfolio.

 

At March 31, 2013, the allowance contained $1,600,000 in specific allocations for impaired loans whereas at December 31, 2012 there was $1,810,000 specifically allocated. There was $9.2 million of recorded investment on impaired loans at March 31, 2013 compared to $11.7 million at year-end 2012. At March 31, 2013, the recorded investment on impaired loans requiring no reserves was $3.9 million, a decrease of $1.2 million since year-end 2012. In the first quarter of 2013, there was one relationship that was removed from TDR status. The specific allocation associated with the loan was $34,000 at year-end 2012. For both March 31, 2013 and year-end 2012, over 40% of specifically identified loans required no reserves. In many cases, these loans had charge-offs since the time of their initial impairment, which reduced principal to the current value of assigned collateral or expected repayment, therefore no further specific reserve is required on these loans.

 

Recorded investment on specifically identified loans requiring reserves was $5.3 million at March 31, 2013 compared to $6.6 million at year-end 2012.

 

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 2012 to March 31, 2013, the recorded investment in accruing past due and non-accrual loans decreased by $743,000. This was evidenced by a $102,000 decrease in the recorded investment in past due loans and a $641,000 decrease in the recorded investment in non-accrual loans in the first three months of 2013.

 

The recorded investment of accruing loans past due 30-59 days was $76,000 at March 31, 2013; a decrease of $55,000 since December 31, 2012. There were eight loans past due 30-59 days at March 31, 2013.

 

-48-
 

 

COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

The recorded investment of accruing loans past due 60-89 days decreased $47,000 since year-end 2012 and was $83,000 at March 31, 2013. There were two loans comprising the entire past due balance at the end of March 2013.

 

There were no accruing loans with a recorded investment past due 90 days and greater at either March 31, 2013 or year-end 2012.

 

The Bank’s delinquency has been reduced compared to prior periods and compares favorably to typical industry averages. The credit review process will continue to be stringent; however, it is possible that past dues could fluctuate in future periods.

 

Non-accrual loans totaled $3.3 million at March 31, 2013 which is a reduction since year-end 2012 when non-accrual loans totaled $3.9 million. The majority of the non-accrual notes are secured by developed real estate, only 2% of the total is secured by undeveloped real estate. At March 31, 2013, there were specific allocations of $1.3 million in the allowance for any estimated collateral deficiency on non-accrual loans.

 

Overall net charge-offs for the first quarter of 2013 were $81,000 which is much lower than the $940,000 for the first three months of 2012. The corresponding ratio of annualized net charge-offs to average loans for the first quarter of 2013 was 0.24% while the ratio of annualized net charge-offs to average loans was 2.54% for the first three months of 2012.

 

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 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. Aside from that single transaction, normal recurring charge offs would have been less than 1% of total loans during the first three months of 2012.

 

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 risk11.

 

 

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.

 

-49-
 

 

COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

The loan maturities and rate sensitivity of the loan portfolio at March 31, 2013 are set forth below:

 

   Within   Three to   One to   After     
   Three Months   Twelve Months   Five Years   Five Years   Total 
Commercial  $7,104,648   $13,699,120   $14,763,014   $6,811,793   $42,378,575 
Commercial Real Estate:                         
General   4,009,001    9,726,349    39,351,338    1,213,812    54,300,500 
Construction   127,390    1,582,705    573,262    0    2,283,357 
Consumer:                         
Lines of credit   634,412    1,017,152    3,192,452    3,961,274    8,805,290 
Other   37,371    115,154    917,747    774,501    1,844,773 
Credit card   55,953    171,924    259,473    0    487,350 
Residential   0    251,780    4,214    15,964,759    16,220,753 
   $11,968,775   $26,564,184   $59,061,500   $28,726,139   $126,320,598 
Loans at fixed rates  $7,812,723   $16,808,071   $43,882,976   $19,875,102   $88,378,872 
Loans at variable rates   4,156,052    9,756,113    15,178,524    8,851,037    37,941,726 
   $11,968,775   $26,564,184   $59,061,500   $28,726,139   $126,320,598 

 

At March 31, 2013, there were 70% of the loan balances carrying a fixed rate and 30% a floating rate. 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. 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.

 

The maturity distribution of the loan portfolio has lengthened over the last several years but still remains at a level which is within the parameters determined to be acceptable by management. Contributing to the change in distribution is the increase in the mortgage loan portfolio. Typically management strives to retain only 10-15% of residential mortgages originated because of the longer contractual terms generally associated with mortgage products. At March 31, 2013, approximately 23% of the entire loan portfolio had a contractual maturity longer than five years. To control extension risk, management tries to ensure that loans with a longer contractual maturity are either floating rate or have a repricing or balloon date that is much shorter than the amortization period. A majority of the loans in the greater than five year contractual maturity are residential mortgage loans. Statistically loans of this type do not normally remain on the books until maturity as a result of customer repricing opportunities or changes in circumstance. Additionally, the mortgage staff remains focused on originating loans saleable into the secondary market, thus minimizing the number that is booked into the held for investment portfolio.

 

Foreclosed assets were $3.1 million at March 31, 2013 which was an increase of $292,000 since December 31, 2012. These assets consist of relinquished properties through the collection process which were previously customer collateral supporting various borrowings. There were four lot sales during the first three months of 2013 and four properties were added. At March 31, 2013 there were 28 real estate holdings and at December 31, 2012 there were 24 real estate holdings.

 

-50-
 

 

COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

Deposit balances were $183.9 million at March 31, 2013 down from $184.2 million at December 31, 2012. Mostly as a result of the expiration of TAG, non-interest bearing deposits decreased $8.3 million since year-end 2012. A majority of the deposits were transferred to interest bearing accounts. Interest-bearing accounts increased $8.0 million since year-end 2012. Typically the Bank experiences a notable seasonal fluctuation in the deposit accounts of its largest public fund customers in the first quarter of each year; partially offsetting 2013’s increase was a $3.4 million decrease in the time deposit portfolio since year-end 2012. Since year-end 2012, there was only one significant withdrawal as a result of the expiration of TAG; otherwise all of the Bank’s deposits remained. The withdrawal was executed in January and was for $2.2 million.

 

The Company had a $5.0 million term loan with Fifth Third secured by the common stock of the Bank that was in default at year-end 2012. In addition to the outstanding principal due, there was accrued interest of $763,000 at December 31, 2012. On March 20, 2013, the Company, with approval from the FRB, borrowed $1,280,000 from a group of investors and settled its debt in full with Fifth Third for $500,000. At closing, Fifth Third released its secured interest in the common stock of the Bank. The new senior debt bears interest at a fixed rate of 8.00% per annum and is payable quarterly, in arrears. The new note matures on March 31, 2015 and is secured by the Bank’s common stock. The extinguishment of debt resulted in a gain of $5.3 million.

 

Shareholders’ equity was approximately $4.0 million on March 31, 2013. On December 31, 2012, the balance was $(1.2) million. The net increase of $5.2 million was made up of net income recorded in the first three months of 2013 offset partially by decreases in accumulated other comprehensive income (security market value adjustments). The book value per share was $2.72 at March 31, 2013.

 

The Bank’s capital ratios have risen since year-end 2012. At March 31, 2013, the Bank’s total risk-based capital ratio was 8.04% and its tier one to average assets ratio was 4.57%. The Bank’s total risk-based capital ratio at December 31, 2012 was 7.88%. Its tier one to average assets ratio was 4.53% at year-end 2012. The total risk-based capital ratio improved because of the Bank’s earnings recorded in the first three months along with a capital contribution of $25,000 from the Company. Achieving a total risk-based capital ratio above 8.00% qualifies the Bank to be considered adequately capitalized according to prompt corrective action regulation administered by federal banking agencies. The Bank was considered under-capitalized at year-end 2012.

 

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 the December 2010 capital reporting period and remains out of compliance at March 31, 2013. In order to attain the level of capital required by the Consent Order, the Bank would have needed additional capital of $7,980,000 on March 31, 2013 based on its asset mix and size. This is comparable to $7,917,000 that would have been needed on December 31, 2012.

 

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. 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.

 

-51-
 

 

COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

The Bank reached an adequately capitalized regulatory capital category at March 31, 2013. Achievement of the capital level stipulated in the Directive will be formally communicated to the FDIC through the submission of the quarterly Call Report as well as the quarterly written communication expected to be submitted by management at the end of April.

 

RESULTS OF OPERATIONS

 

The net income for the first three months of 2013 was $5.3 million which was $5.4 million more than the loss of $64,000 recorded for the first three months of 2012. The corresponding basic and diluted earnings per share for the first three months of 2013 was $3.61. The basic and diluted loss per share for the first quarter of 2012 was $(0.04). The income recorded in the first three months of 2013 stemmed mainly from a $5.3 million gain on debt extinguishment.

 

For the first three months of 2013, the annualized return on the Company’s average total assets was 10.45% compared to (0.12)% for the first three months of 2012. The annualized return on average equity was not meaningful in either quarter because the average of shareholders’ equity was a negative number in both cases. Going forward the Company’s average equity will be a positive number making the result relevant to operating performance.

 

-52-
 

 

COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

Another component of the Company’s revenue is its net interest income. The Company’s net interest income was slightly less for the first three months of 2013 compared to the similar period in 2012 but the net interest margin was higher. 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.

 

   Three Months ended March 31, 
   2013   2012 
   Average       Average   Average       Average 
   Balance   Interest   Rate   Balance   Interest   Rate 
Assets                              
Federal funds sold and interest-bearing deposits with banks  $17,365,897   $10,329    0.24%  $19,185,430   $11,735    0.24%
Securities   40,697,873    156,889    1.54    35,029,857    175,194    2.00 
Loans (including held for sale and non accrual)   132,155,043    1,876,474    5.68    147,875,174    2,153,005    5.82 
    190,218,813    2,043,692    4.30    202,090,461    2,339,934    4.63 
Other assets   12,854,466              12,363,606           
   $203,073,279             $214,454,067           
Liabilities and Shareholders’ Equity                              
Interest-bearing deposits  $146,553,500   $278,912    0.76%  $158,799,892   $404,273    1.02%
Repurchase agreements   10,117,007    15,214    0.60    9,145,140    17,390    0.76 
Subordinated debentures and notes payable   4,670,667    32,717    2.80    9,500,000    107,979    4.55 
    161,341,174    326,843    0.81    177,445,032    529,642    1.19 
Non-interest-bearing deposits   36,507,795              37,258,758           
Other liabilities   5,528,209              1,195,828           
Shareholders’ Equity   (303,899)             (1,445,551)          
   $203,073,279             $214,454,067           
Net interest income        1,716,849              1,810,292      
Net interest spread on earning assets             3.49%             3.44%
Net interest margin on earning assets             3.61%             3.58%
Average interest-earning assets to average interest-bearing liabilities             117.90%             113.89%

 

The net interest spread on average earning assets increased five basis points to 3.49% in the past twelve months. The net interest margin increased by three basis points from 3.58% for the first three months of 2012 to 3.61% for the first three months of 2013. The net interest income for the first three months of 2013 was $1.7 million compared to a figure of $1.8 million for the same three months in 2012. Additionally, there was a decrease in average earning assets of $11.9 million when comparing the first quarter of 2013 to the first quarter of 2012. In spite of having less net interest income and fewer average earning assets, 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.

 

-53-
 

 

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 4.30% for the three month period ending March 31, 2013 compared to 4.63% for the same period in 2012. One of the reasons for the decrease stems from the yield on the securities portfolio declining by 46 basis points between the first quarter of 2012 and that of 2013. Throughout last year, as securities matured or were called, the replacement securities purchased yielded lower rates as a result of differences in the rate environment.

 

The primary reason for the decrease in the average rate earned on earning assets was the reduction in the yield on the loan portfolio, the Company’s largest earning asset category. The average rate earned on the loan portfolio was 5.68% in the first quarter of 2013, a reduction of 14 basis points compared to the first quarter of 2012. A majority of the yield decrease was due to a $15.7 million contraction in the loan portfolio over the last twelve months. Several of the loan payoffs were on higher rate credits thus changing the rate distribution of the loan portfolio. The Bank has an internal prime rate that is 175 basis points above the national prime rate, which can make it difficult to compete with other local banks when loans come up for renewal.

 

Decreases to the overall yield on interest earning assets were more than offset by rate reductions on the funding side. Since the first quarter of 2012, the cost of funds improved 38 basis points. The main contributing factor was a 26 basis point improvement in the rate paid on interest bearing deposits when comparing the first three months of 2013 to that of the similar period of 2012; a majority of the improvement was a 15 basis point reduction in the average rate paid on the time deposit portfolio over the last twelve months. As time deposits are maturing, the Bank has been successful at securing lower rates and longer maturities if the deposits need to be replaced.

 

Additionally, there were improvements in the average rate paid on repurchase agreements, subordinated debentures and notes payable between the first quarter of 2013 and the first quarter of 2012. The average rate paid on repurchase agreements was 16 basis points less. Decreases to the average rate on subordinated debentures and notes payable is directly related to the settlement with Fifth Third which occurred late in the first quarter of 2013. As a result there was a reduction in interest bearing liabilities of $4.8 million. Since the new senior debt bears interest at a rate 2% higher than the former Fifth Third note payable, there will be an increase in the average rate paid however it will be offset by a much smaller balance outstanding.

 

Management has focused on overseeing the continued improvement in the cost of funds, especially in light of the restrictions placed by the Consent Order as well as the expiration of TAG which attracted customers to transfer their deposits to interest-bearing accounts. Regardless, excess liquidity at the FRB is slated to repay maturing time deposits which is anticipated to mostly offset the effects of the TAG expiration. As such, it is expected that the net interest margin will continue rising throughout the remaining quarters of 2013.

 

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.

 

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COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

The Company uses a sophisticated computer program to perform analysis of interest rate risk, assist with asset liability management, and model and measure interest rate sensitivity. Interest rate sensitivity varies with different types of earning assets and interest-bearing liabilities. Overnight investments, of which rates change daily, and loans tied to the prime rate, differ considerably from long term investment securities and fixed rate loans. Interest bearing checking and money market accounts are more interest sensitive than long term time deposits and fixed rate FHLB advances. Comparison of the repricing intervals of interest earning assets to interest bearing liabilities is a measure of interest sensitivity gap. Balancing this gap is a continual challenge in a highly competitive and changing rate environment.

 

Details of the repricing gap at March 31, 2013 were:

 

   Interest Rate Sensitivity Period 
   Within   Three to   One to   After     
   Three   Twelve   Five   Five     
   Months   Months   Years   Years   Total 
Earning assets                         
Interest-bearing deposits in other financial institutions  $21,418,199   $0   $0   $0   $21,418,199 
Securities (including FHLB stock)   4,593,445    7,191,735    23,124,194    3,990,006    38,899,380 
Loans held for sale   32,943    108,168    642,511    4,486,975    5,270,597 
Loans   51,992,669    17,124,257    42,736,318    14,467,354    126,320,598 
    78,037,256    24,424,160    66,503,023    22,944,335    191,908,774 
Interest-bearing liabilities                         
Savings and checking   61,913,108    0    0    0    61,913,108 
Time deposits <$100,000   10,858,710    25,192,055    44,135,672    47,000    80,233,437 
Time deposits >$100,000   1,926,972    5,332,561    2,524,915    0    9,784,448 
Repurchase agreements and Federal funds purchased   10,174,229    0    0    0    10,174,229 
Notes payable and other borrowings   4,500,000    0    1,280,000    0    5,780,000 
    89,373,019    30,524,616    47,940,587    47,000    167,885,222 
Net asset (liability) repricing gap  $(11,335,763)  $(6,100,456)  $18,562,436   $22,897,335   $24,023,552 
Cumulative net asset (liability) repricing gap  $(11,335,763)  $(17,436,219)  $1,126,217   $24,023,552      

 

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 Federal Reserve has forecasted, a negative repricing gap should be helpful for further reduction to the Company’s overall interest expense, which is likely to translate into higher net interest income and an increased net interest margin. Conversely, 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 above simply illustrates what the Company is contractually able to change in certain time frames.

 

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COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

There was no provision for loan losses for the first three months of 2013. In the first three months of 2012, the provision for loan losses was $75,000. The provision expense is associated with changes in historical loss calculations, economic condition (local and national) as well as delinquency, charge offs and changes to credit quality grades; up and down. A methodical assessment of these factors generates the reserves required for the risk in the Bank’s loan portfolio and the required provision expense. Management will continue to review the allowance with the intent of maintaining it at an appropriate level for the portfolio’s credit quality and perceived risk factors. The provision for loan losses is an estimate and may be increased or decreased in the future.

 

Non-interest income recorded in the first three months of 2013 was $5.6 million compared to $302,000 recorded for the similar period in 2012. The largest difference stemmed from the settlement of debt with Fifth Third. On March 20, 2013, the Company, with approval from the FRB, borrowed $1,280,000 from a group of investors and settled its debt in full with Fifth Third for $500,000. At closing, the balance owed to Fifth Third was approximately $5.8 million. The extinguishment of debt resulted in a gain of $5.3 million. Additionally, gains on the sale of residential real estate loans were $29,000 higher in the first quarter of 2013 than the same period in 2012. The rate environment continues to be very conducive to mortgage lending activity. A large portion of the originated loans are refinance transactions but, in the first three months of 2013, financing for home purchases has nearly doubled as compared to all of 2012. This change in composition of mortgage activity supports the idea that there has been an improvement in the local economy.

 

Non-interest expenses for the first three months of 2013 were $1.9 million. Non-interest expenses for the first three months of 2012 were $2.1 million. Several categories decreased contributing to the $157,000 variance between the two periods.

 

Salary and benefit expenses, the largest category of non-interest expenses, were $915,000 for the first quarter of 2013. For the similar period in 2012, the total was $970,000. There were on average 3 fewer full time equivalent (“FTE”) employees when comparing the two time periods. A portion of the decrease was related to retirements. In February of 2012, two commercial lenders retired. Other vacancies were related to the timing of turnover and may not be a permanent decrease in FTE’s.

 

Foreclosed asset impairment charges were $8,000 in the first three months of 2013 compared to $91,000 for the similar period in 2012. The $83,000 decrease stems from fewer properties held as well as stabilized local real estate values. There were 28 foreclosed properties at March 31, 2013 and 32 at March 31, 2012.

 

FDIC insurance premiums were comparable when comparing the first three month period of 2013 and the first quarter of 2012. In the first quarter of 2012, the Bank was considered under-capitalized. Beginning with the March 31, 2013 regulatory capital reporting period, the Bank achieved an adequately capitalized regulatory capital status. The improvement in regulatory capital ratio is anticipated to translate into an FDIC premium reduction of at least 30% per quarter beginning with the second quarter of 2013.

 

Other non-interest expenses were $323,000 in the first quarter of 2013 and $369,000 for the like period in 2012; a reduction of $46,000. The main contributing factor is a $64,000 reduction in expenses to administer impaired assets. In the first three months of 2013, these expenses totaled $103,000. Similarly, these expenses totaled $167,000 in the first quarter of 2012. Fewer expenses related to administering impaired assets supports management’s assessment of improved credit quality over the past several quarters.

 

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COMMUNITY SHORES BANK CORPORATION

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

OPERATIONS

 

As a result of the large gain on the extinguishment of debt, the Company recorded income tax expense from operations in the amount of $105,000. This amount represents projected taxable earnings subject to alternative minimum taxation which may fluctuate throughout the year with changes in operating results. Additionally, the gain on the extinguishment of debt may result in a reduction of net operating loss carry forward tax attributes by an estimated $5.3 million.  Even so, the Company’s estimated net operating loss carry forward remaining would be over $6 million.

 

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 March 31, 2013. 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 March 31, 2013.

 

There have been no changes in the internal control over financial reporting during the quarter ended March 31, 2013, that have materially affected, or are 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 March 31, 2013.

 

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 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 June 30, 2004 Form 10-QSB (SEC file number 333-63769).
3.2   Bylaws of the Company are incorporated by reference to exhibit 3(ii) of the Company’s Form 8-K filed July 5, 2006 (SEC file number 000-51166).
10.1   Settlement Agreement and Release between the Company and Fifth Third dated March 20, 2013 (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed March 25, 2013.
10.2   Convertible Secured Note Purchase Agreement, Note and Pledge Agreement between the Company and 1030 Norton LLC dated March 20, 2013 (incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed March 25, 2013).
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
     
May 15, 2013 By: /s/ Heather D. Brolick
Date Heather D. Brolick
  President and Chief Executive Officer
  (principal executive officer)
     
May 15, 2013 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 June 30, 2004 Form 10-QSB (SEC file number 333-63769).
3.2   Bylaws of the Company are incorporated by reference to exhibit 3(ii) of the Company’s Form 8-K filed July 5, 2006 (SEC file number 000-51166).
10.1   Settlement Agreement and Release between the Company and Fifth Third dated March 20, 2013 (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed March 25, 2013.
10.2   Convertible Secured Note Purchase Agreement, Note and Pledge Agreement between the Company and 1030 Norton LLC dated March 20, 2013 (incorporated by reference to Exhibit 10.2 of the Company’s Form 8-K filed March 25, 2013).
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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