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EX-32.1 - EXHIBIT 32.1 - COMMUNITY SHORES BANK CORPv386465_ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - COMMUNITY SHORES BANK CORPv386465_ex31-1.htm
EX-32.2 - EXHIBIT 32.2 - COMMUNITY SHORES BANK CORPv386465_ex32-2.htm
EX-31.2 - EXHIBIT 31.2 - COMMUNITY SHORES BANK CORPv386465_ex31-2.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 June 30, 2014 _____________________________________________________________

 

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 August 11, 2014, 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 44
       
  Item 3. Quantitative and Qualitative Disclosures about Market Risk 61
       
  Item 4. Controls and Procedures 61
       
PART II. Other Information  
     
  Item 1. Legal Proceedings 62
       
  Item 1A. Risk Factors 62
       
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 62
       
  Item 3. Defaults upon Senior Securities 63
       
  Item 4. Mine Safety Disclosures 63
       
  Item 5. Other Information 63
       
  Item 6. Exhibits 63
     
  Signatures 64

 

 
 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   June 30,   December 31, 
   2014   2013 
   (unaudited)   (audited) 
ASSETS          
Cash and due from financial institutions  $4,695,017   $3,758,535 
Interest-bearing deposits in other financial institutions   18,381,632    13,374,206 
Total cash and cash equivalents   23,076,649    17,132,741 
Securities available for sale (at fair value)   31,248,601    31,230,246 
Loans held for sale   111,200    240,055 
Loans   132,703,239    131,554,244 
Less: Allowance for loan losses   2,741,560    2,809,642 
Net loans   129,961,679    128,744,602 
Federal Home Loan Bank stock (at cost)   450,800    450,800 
Premises and equipment, net   9,148,072    9,145,467 
Accrued interest receivable   433,971    466,538 
Foreclosed assets   2,498,608    2,558,299 
Other assets   1,003,714    810,590 
Total assets  $197,933,294   $190,779,338 
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Deposits          
Non-interest-bearing  $33,285,926   $33,313,136 
Interest-bearing   143,736,581    138,626,729 
Total deposits   177,022,507    171,939,865 
Federal funds purchased and repurchase agreements   10,020,151    8,428,046 
Subordinated debentures   4,500,000    4,500,000 
Notes payable   1,280,000    1,280,000 
Accrued expenses and other liabilities   1,056,616    968,558 
Total liabilities   193,879,274    187,116,469 
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   (9,063,675)   (9,276,599)
Accumulated other comprehensive loss   (178,996)   (357,223)
Total shareholders’ equity   4,054,020    3,662,869 
Total liabilities and shareholders’ equity  $197,933,294   $190,779,338 

 

See accompanying notes to consolidated financial statements.

 

- 1 -
 

 

COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 

   Three Months   Three Months   Six Months   Six Months 
   Ended   Ended   Ended   Ended 
   June 30,   June 30,   June 30,   June 30, 
   2014   2013   2014   2013 
Interest and dividend income                    
Loans, including fees  $1,721,753   $1,714,892   $3,435,813   $3,591,366 
Securities   108,815    137,710    229,193    294,599 
Federal funds sold, FHLB dividends and other income   12,742    7,984    23,342    18,313 
Total interest and dividend income   1,843,310    1,860,586    3,688,348    3,904,278 
Interest expense                    
Deposits   210,977    252,138    425,606    531,050 
Repurchase agreements, federal funds purchased, and other debt   12,281    14,512    23,967    29,726 
Federal Home Loan Bank advances and notes payable   55,332    55,321    110,094    88,038 
Total interest expense   278,590    321,971    559,667    648,814 
Net Interest Income   1,564,720    1,538,615    3,128,681    3,255,464 
Provision for loan losses   0    0    0    0 
Net Interest Income After Provision for Loan Losses   1,564,720    1,538,615    3,128,681    3,255,464 
Non-interest income                    
Service charges on deposit accounts   158,253    161,852    296,721    311,303 
Gain on sale of loans   38,482    59,921    64,710    127,164 
Gain on sale of securities   0    0    7,409    0 
Gain on sale of foreclosed assets   43,534    44,377    90,532    44,377 
Gain on sale of premises and equipment   0    0    0    1,000 
Gain on the extinguishment of debt   0    0    0    5,262,653 
Other   206,330    160,449    396,456    316,725 
Total non-interest income   446,599    426,599    855,828    6,063,222 
Non-interest expense                    
Salaries and employee benefits   966,454    912,135    1,917,901    1,827,045 
Occupancy   151,933    149,239    325,407    316,269 
Furniture and equipment   82,991    92,156    156,432    198,199 
Advertising   10,828    9,100    21,313    24,111 
Data processing   166,237    154,055    321,704    300,739 
Professional services   84,699    114,164    171,104    204,812 
Foreclosed asset impairment   54,197    101,141    70,028    108,740 
FDIC insurance   108,151    51,227    213,601    224,068 
Other   283,628    306,732    574,095    629,905 
Total non-interest expense   1,909,118    1,889,949    3,771,585    3,833,888 
Income Before Federal Income Taxes   102,201    75,265    212,924    5,484,798 
Federal income tax expense   0    0    0    105,000 
Net Income  $102,201   $75,265   $212,924   $5,379,798 
Basic average shares outstanding   1,468,800    1,468,800    1,468,800    1,468,800 
Diluted average shares outstanding   1,468,800    1,468,800    1,468,800    1,468,800 
Basic earnings per share  $0.07   $0.05   $0.14   $3.66 
Diluted earnings per share  $0.07   $0.05   $0.14   $3.66 

 

See accompanying notes to consolidated financial statements.

 

- 2 -
 

 

COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

 

   Three Months   Three Months   Six Months   Six Months 
   Ended   Ended   Ended   Ended 
   June 30, 2014   June 30, 2013   June 30,2014   June 30, 2013 
                 
Net income  $102,201   $75,265   $212,924   $5,379,798 
                     
Other comprehensive income (loss):                    
Unrealized holding gains (losses) on available for sale securities   131,939    (468,823)   170,024    (545,061)
Less reclassification adjustments for unrealized gains later recognized in income   0    0    (7,409)1   0 
    131,939    (468,823)   162,615    (545,061)
Tax effect   15,612    0    15,612    0 
Total other comprehensive income (loss)   147,551    (468,823)   178,227    (545,061)
                     
Comprehensive income (loss)  $249,752   $(393,558)  $391,151   $4,834,737 

 

 

 

1 Appears on condensed consolidated statement of income as a gain on sale of securities.

 

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, 2013   1,468,800   $13,296,691   $(14,816,593)  $280,806   $(1,239,096)
                          
Net income             5,379,798         5,379,798 
Other comprehensive loss                  (545,061)   (545,061)
                          
Balance at June 30, 2013   1,468,800   $13,296,691   $(9,436,795)  $(264,255)  $3,595,641 
                          
Balance at January 1, 2014   1,468,800   $13,296,691   $(9,276,599)  $(357,223)  $3,662,869 
                          
Net income             212,924         212,924 
Other comprehensive income                  178,227    178,227 
                          
Balance at June 30, 2014   1,468,800   $13,296,691   $(9,063,675)  $(178,996)  $4,054,020 

 

See accompanying notes to consolidated financial statements.

  

- 4 -
 

 

COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

   Six Months Ended   Six Months Ended 
   June 30, 2014   June 30, 2013 
Cash flows from operating activities          
Net income  $212,924   $5,379,798 
Adjustments to reconcile net income to net cash from operating activities:          
Depreciation and amortization   183,067    202,781 
Net amortization of securities   143,647    196,288 
Net realized gain on sale of securities   (7,409)   0 
Net realized gain on sale of loans   (64,710)   (127,164)
Net realized gain on sale of foreclosed assets   (90,532)   (44,377)
Net realized gain on sale of premises and equipment   0    (1,000)
Net realized gain on the extinguishment of debt   0    (5,262,653)
Foreclosed asset impairment   70,028    108,740 
Originations of loans for sale   (2,315,860)   (5,536,206)
Proceeds from loan sales   2,509,425    5,712,239 
Net change in:          
Accrued interest receivable and other assets   (144,946)   (83,194)
Accrued interest payable and other liabilities   88,058    111,130 
Net cash from operating activities   583,692    656,382 
Cash flows from investing activities          
Activity in available for sale securities:          
Sales   661,182    0 
Maturities, prepayments and calls   4,051,814    4,881,923 
Purchases   (4,704,973)   0 
Loan originations and (payments), net   (1,397,414)   1,599,948 
Additions to premises and equipment, net   (185,672)   (50,394)
Proceeds from the sale of foreclosed assets   260,532    493,667 
Net cash from (used in) investing activities   (1,314,531)   6,925,144 
Cash flows from financing activities          
Net change in deposits   5,082,642    (15,041,012)
Net change in federal funds purchased and   1,592,105    (9,821)
Other borrowing activity:          
Repayment of note payable   0    (500,000)
Issuance of senior debt   0    1,280,000 
Net cash from (used in) financing activities   6,674,747    (14,270,833)
Net change in cash and cash equivalents   5,943,908    (6,689,307)
Beginning cash and cash equivalents   17,132,741    20,297,115 
Ending cash and cash equivalents  $23,076,649   $13,607,808 
Supplemental cash flows information:          
Cash paid during the period for interest  $502,887   $592,519 
Cash paid during the period for federal income tax   86,000    0 
Transfers from loans to foreclosed assets   229,837    582,024 
Transfers from loans held for sale to portfolio   0    994,397 
Foreclosed asset sales financed by the Bank   49,500    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 and six months ended June 30, 2014 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 June 30, 2014 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, 2013. 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, however 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 the first half of 2014.

 

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. In recent periods, with charge-off activity lessening, the calculated historical loss factor assigned to general allocations was considerably reduced. The reduction was large enough that management chose to define and implement a minimum loss percentage for these segments. The minimum loss percentage is meant to ensure adequate coverage for incurred losses in loan pools.

 

- 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.

 

For 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.

 

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 less costs to sell.

 

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 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.

 

- 8 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

RECENT DEVELOPMENTS:

 

In January 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-04, Receivables- Trouble Debt Restructurings by Creditors (Topic 205). ASU 2014-04 clarifies when a creditor should be considered to have received physical possession of residential real estate property during a foreclosure. ASU 2014-04 establishes a loan receivable should be derecognized and the real estate property recognized upon the creditor obtaining legal title to the residential real estate property upon completion of foreclosure or the borrower conveying all interest in the residential real estate property to the creditor to satisfy the loan. The provisions of ASU 2014-04 are effective for annual periods beginning after December 15, 2014. The adoption of this guidance is not expected to have a material effect on the Company’s financial position or results of operations.

 

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The amendments in this update create a new Topic 606 in the FASB Accounting Standard Codification ® (“ASC” or “Codification”). In addition to superseding and replacing nearly all existing U.S. GAAP revenue recognition guidance, including industry-specific guidance, ASC 606 establishes a new control-based revenue recognition model, changes the basis for deciding when the revenue is recognized over time or at a point in time, provides new and more detailed guidance on specific topics and expands and improves disclosures about revenue. In addition, ASU 2014-09 adds a new Subtopic to the Codification, ASC 340-40, Other Assets and Deferred Costs: Contracts with customers to provide guidance on costs related to obtaining a contract with a customer and costs incurred in fulfilling contract with a customer that are not in the scope of another ASC Topic. The new guidance does not apply to certain contracts within the scope of other ASC Topics, such as lease contracts, insurance contracts, financing arrangements, financial instruments, guarantees other than product or service warranties, and nonmonetary exchanges between entities in the same line of business to facilitate sales to customers. The amendments are effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. The adoption of this guidance is not expected to have a material effect on the Company’s financial position of results of operations.

 

In June 2014, FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. This ASU requires two accounting changes. First, repurchase-to-maturity transactions will be accounted for as secured borrowing transactions on the balance sheet, rather than sales. Second, for repurchase financing arrangements, the ASU requires separate accounting for a transfer of a financial asset executed contemporaneously with (or in contemplation of) a repurchase agreement with the same counterparty, which also will generally result in secured borrowing accounting for the repurchase agreement. The ASU also introduces new disclosures to increase transparency about the types of collateral pledged for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions that are accounted for as secured borrowings. The ASU also requires a transferor to disclose information about transactions accounted for as a sale in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets through an agreement with the transferee. The accounting changes and disclosure for certain transactions accounted for as a sale are effective for the first interim period beginning in 2015. The disclosure for transactions accounted for as secured borrowings is required for interim periods beginning after March 15, 2015. The adoption of this guidance is not expected to have a material effect on the Company’s financial position or results of operations.

 

- 9 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

FASB also issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit when a Net Operating Loss Carryforward or Tax Credit Carryforward Exists. This update requires an unrecognized tax benefit, or portion of an unrecognized tax benefit, to be presented in the statement of financial position as a reduction to a deferred tax asset for a net operating loss carryforward or a tax credit carryforward. However, to the extent that a net operating loss carryforward or a tax credit carryforward at the reporting date is not available under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position, the unrecognized tax benefit is to be presented in the statement of financial position as a liability. No new recurring disclosures are required. The amendments are effective for public business entities for annual periods beginning after December 15, 2013, and interim periods within those periods. The amendments are to be applied on a prospective basis to all unrecognized tax benefits that exist at the effective date, although retrospective application is permitted. The adoption of this guidance did not have a material effect on the Company’s financial position or results of operations.

 

The Company continued its trend of profitability, reporting consolidated earnings of $213,000 or $0.14 per common share for the first six months of 2014 and $102,000 or $0.07 per common share for the second quarter of 2014. Additionally, total assets grew as a result of larger customer deposit account balances which increased the Company’s cash on deposit at the Federal Reserve Bank and funded loan growth. Through earnings in the first half of 2014, the total risk-based capital ratio of the Bank grew 4 basis points to 8.52%. The Bank continues to be considered adequately capitalized according to regulatory capital standards.

 

In spite of the improved financial outcome for the last several quarters, the Company remains subject to additional regulatory scrutiny, as described immediately below, following significant consolidated losses from 2007 through 2011, which resulted primarily from deteriorating asset quality during that recessionary period.

 

On September 2, 2010, the Bank 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”), 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 June 30, 2014.

 

- 10 -
 

 

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”), one of the Company’s primary regulators. 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. At present, the Company’s sole liquidity resource is its cash account balance which, as of June 30, 2014, was approximately $435,000.

 

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

 

2.SECURITIES AVAILABLE FOR SALE

 

The following tables represent the securities held in the Company’s portfolio at June 30, 2014 and at December 31, 2013:

 

       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
June 30, 2014  Cost   Gains   Losses   Value 
                 
US Treasury  $2,518,124   $20,001   $0   $2,538,125 
US Government and federal agency   14,242,004    77,887    (22,338)   14,297,553 
Municipals   1,060,962    13,972    0    1,074,934 
Mortgage-backed and collateralized mortgage obligations– residential   13,301,221    138,085    (101,317)   13,337,989 
   $31,122,311   $249,945   $(123,655)  $31,248,601 

 

       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
December 31, 2013  Cost   Gains   Losses   Value 
                 
US Treasury  $2,525,481   $16,551   $0   $2,542,032 
US Government and federal agency   15,823,511    90,497    (46,602)   15,867,406 
Municipals   1,563,394    27,747    0    1,591,141 
Mortgage-backed and collateralized mortgage obligations– residential   11,354,185    132,797    (257,315)   11,229,667 
   $31,266,571   $267,592   $(303,917)  $31,230,246 

 

- 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 June 30, 2014:

 

   Amortized   Fair 
   Cost   Value 
Due in one year or less  $2,522,342   $2,542,987 
Due from one to five years   15,298,748    15,367,625 
Due from five to ten years   0    0 
Due in more than ten years   0    0 
Mortgage-backed and collateralized mortgage obligations – residential   13,301,221    13,337,989 
   $31,122,311   $31,248,601 

 

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 June 30, 2014 and December 31, 2013:

 

   Less than 12 Months   12 Months or Longer   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
June 30, 2014  Value   Losses   Value   Losses   Value   Losses 
US Government and federal agency  $1,512,150   $(4,036)  $2,971,170   $(18,302)  $4,483,320   $(22,338)
Mortgage-backed and collateralized mortgage obligations - residential   2,911,190    (8,375)   5,150,449    (92,942)   8,061,639    (101,317)
   $4,423,340   $(12,411)  $8,121,619   $(111,244)  $12,544,959   $(123,655)

 

   Less than 12 Months   12 Months or Longer   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
December 31, 2013  Value   Losses   Value   Losses   Value   Losses 
US Government and federal agency  $2,439,145   $(38,342)  $1,031,280   $(8,260)  $3,470,425   $(46,602)
Mortgage-backed and collateralized mortgage obligations - residential   5,604,925    (191,440)   1,473,265    (65,875)   7,078,190    (257,315)
   $8,044,070   $(229,782)  $2,504,545   $(74,135)  $10,548,615   $(303,917)

 

There was one security sold in the six months ended June 30, 2014. Proceeds from the sale were $661,182 with a gain of $7,409 realized. No securities were sold in the three months ended June 30, 2014. No securities were sold in the six or three months ended June 30, 2013.

 

- 12 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

2.SECURITIES AVAILABLE FOR SALE (Continued)

 

Other-Than-Temporary-Impairment

 

Management evaluates securities for other than temporary impairment (“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 June 30, 2014, 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 June 30, 2014, 20 debt securities had unrealized losses with aggregate depreciation of 0.98% from the amortized cost basis. Six of the 20 securities are issued by government agencies and 14 are issued by a government-sponsored entity. It is more likely than not 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 June 30, 2014.

 

- 13 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

3.LOANS

 

Outstanding loan balances by portfolio segment and class at June 30, 2014 and December 31, 2013 were as follows:

 

   June 30, 2014   December 31, 2013 
Commercial  $51,276,448   $47,081,426 
Commercial Real Estate:          
General   56,258,764    57,101,939 
Construction   2,103,444    2,065,308 
Consumer:          
Lines of credit   7,059,544    7,737,439 
Other   1,365,622    1,560,384 
Credit card   472,318    451,009 
Residential   14,225,498    15,611,082 
Net deferred loan fees   (58,399)   (54,343)
    132,703,239    131,554,244 
Less:  Allowance for loan losses   (2,741,560)   (2,809,642)
Loans, net  $129,961,679   $128,744,602 

 

- 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 and six month periods ended June 30, 2014 and 2013 by portfolio segment:

 

Three Months Ended June 30, 2014  Commercial   Commercial
Real Estate
   Consumer   Residential   Unallocated   Total 
Allowance for loan losses:                              
Beginning balance  $426,072   $1,686,614   $396,967   $198,683   $333,873   $3,042,209 
Charge-offs   (20,890)   (163,692)   (48,450)   (83,384)   0    (316,416)
Recoveries   5,150    2,557    8,060    0    0    15,767 
Provision for loan losses   17,915    (57,097)   33,423    114,480    (108,721)   0 
Ending balance  $428,247   $1,468,382   $390,000   $229,779   $225,152   $2,741,560 

 

Three Months Ended June 30, 2013  Commercial   Commercial
Real Estate
   Consumer   Residential   Unallocated   Total 
Allowance for loan losses:                              
Beginning balance  $524,383   $2,072,756   $330,028   $169,549   $205,581   $3,302,297 
Charge-offs   0    (15,314)   (20,306)   0    0    (35,620)
Recoveries   16,616    0    3,981    0    0    20,597 
Provision for loan losses   (101,006)   (136,855)   105,808    (12,143)   144,196    0 
Ending balance  $439,993   $1,920,587   $419,511   $157,406   $349,777   $3,287,274 

 

- 15 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

Six Months Ended June 30, 2014  Commercial   Commercial
Real Estate
   Consumer   Residential   Unallocated   Total 
Allowance for loan losses:                              
Beginning balance  $339,048   $1,713,193   $424,824   $227,767   $104,810   $2,809,642 
Charge-offs   (20,890)   (163,692)   (48,724)   (115,585)   0    (348,891)
Recoveries   258,950    2,557    19,302    0    0    280,809 
Provision for loan losses   (148,861)   (83,676)   (5,402)   117,597    120,342    0 
Ending balance  $428,247   $1,468,382   $390,000   $229,779   $225,152   $2,741,560 

 

Six Months Ended June 30, 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)   (25,025)   (38,597)   (54,599)   0    (158,474)
Recoveries   56,200    0    6,571    0    0    62,771 
Provision for loan losses   (158,152)   (320,690)   120,078    8,987    349,777    0 
Ending balance  $439,993   $1,920,587   $419,511   $157,406   $349,777   $3,287,274 

 

- 16 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as of June 30, 2014 and December 31, 2013:

 

June 30, 2014  Commercial   Commercial
Real Estate
   Consumer   Residential   Unallocated   Total 
Allowance for loan losses:                              
Ending allowance balance attributable to loans:                              
Individually evaluated for impairment  $116,404   $1,121,089   $198,072   $98,405   $0   $1,533,970 
Collectively evaluated for impairment   311,843    347,293    191,928    131,374    0    982,438 
Unallocated   0    0    0    0    225,152    225,152 
Total ending allowance balance  $428,247   $1,468,382   $390,000   $229,779   $225,152   $2,741,560 
                               
Loans:                              
Individually evaluated for impairment  $1,463,749   $8,975,347   $420,847   $861,525   $0   $11,721,468 
Collectively evaluated for impairment   49,905,856    49,481,674    8,508,443    13,406,130    0    121,302,103 
Total ending loans balance  $51,369,605   $58,457,021   $8,929,290   $14,267,655   $0   $133,023,571 

 

December 31, 2013  Commercial   Commercial
Real Estate
   Consumer   Residential   Unallocated   Total 
Allowance for loan losses:                              
Ending allowance balance attributable to loans:                              
Individually evaluated for impairment  $28,705   $1,302,677   $191,887   $87,635   $0   $1,610,904 
Collectively evaluated for impairment   310,343    410,516    232,937    140,132    0    1,093,928 
Unallocated   0    0    0    0    104,810    104,810 
Total ending allowance balance  $339,048   $1,713,193   $424,824   $227,767   $104,810   $2,809,642 
                               
Loans:                              
Individually evaluated for impairment  $1,165,730   $6,784,821   $518,428   $1,127,955   $0   $9,596,934 
Collectively evaluated for impairment   46,016,674    52,490,365    9,267,130    14,524,492    0    122,298,661 
Total ending loans balance  $47,182,404   $59,275,186   $9,785,558   $15,652,447   $0   $131,895,595 

 

- 17 -
 

 

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 June 30, 2014 and December 31, 2013. For purposes of this disclosure, the unpaid principal balance is not reduced for partial charge-offs.

 

   Recorded   Unpaid Principal   Related 
June 30, 2014  Investment   Balance   Allowance 
With no related allowance recorded:               
Commercial  $1,046,475   $1,166,765   $0 
Commercial Real Estate:               
General   6,959,900    7,138,075    0 
Consumer:               
Lines of credit   97,188    97,188    0 
Other   750    750    0 
Residential   251,049    315,913    0 
Subtotal  $8,355,362   $8,718,691   $0 
                
With a related allowance recorded:               
Commercial  $417,274   $430,416   $116,404 
Commercial Real Estate:               
General   2,015,447    2,015,447    1,121,089 
Consumer:               
Lines of credit   291,861    290,774    167,438 
Other   31,048    31,048    30,634 
Residential   610,476    617,726    98,405 
Subtotal  $3,366,106   $3,385,411   $1,533,970 
Total  $11,721,468   $12,104,102   $1,533,970 

 

- 18 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

   Recorded   Unpaid Principal   Related 
December 31, 2013  Investment   Balance   Allowance 
With no related allowance recorded:               
Commercial  $1,049,046   $1,059,514   $0 
Commercial Real Estate:               
General   714,377    744,958    0 
Consumer:               
Lines of credit   107,750    255,128    0 
Other   47,106    109,603    0 
Residential   343,859    554,300    0 
Subtotal  $2,262,138   $2,723,503   $0 
With a related allowance recorded:               
Commercial  $116,684   $116,194   $28,705 
Commercial Real Estate:               
General   6,070,444    6,069,393    1,302,677 
Consumer:               
Lines of credit   296,004    294,323    155,095 
Other   67,568    67,406    36,792 
Residential   784,096    791,471    87,635 
Subtotal  $7,334,796   $7,338,787   $1,610,904 
Total  $9,596,934   $10,062,290   $1,610,904 

 

- 19 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

Non-performing loans, from a past due and accrual status, 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.

 

   Three Months   Three Months   Three Months 
   Average Recorded   Interest Income   Cash Basis 
June 30, 2014  Investment   Recognized   Interest Recognized 
With no related allowance recorded:               
Commercial  $1,034,795   $7,560   $5,133 
Commercial Real Estate:               
General   5,485,590    63,156    62,217 
Consumer:               
Lines of credit   97,346    0    0 
Other   940    0    0 
Residential   418,229    0    0 
Subtotal  $7,036,900   $70,716   $67,350 
                
With a related allowance recorded:               
Commercial  $417,958   $5,411   $5,411 
Commercial Real Estate:               
General   3,607,810    0    0 
Consumer:               
Lines of credit   300,699    4,724    4,419 
Other   31,931    38    0 
Residential   594,390    6,587    6,396 
Subtotal  $4,952,788   $16,760   $16,226 
Total  $11,989,688   $87,476   $83,576 

 

- 20 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

   Three Months   Three Months   Three Months 
   Average Recorded   Interest Income   Cash Basis 
June 30, 2013  Investment   Recognized   Interest Recognized 
With no related allowance recorded:               
Commercial  $1,204,824   $7,924   $7,924 
Commercial Real Estate:               
General   2,297,799    26,299    20,308 
Construction   0    0    0 
Consumer:               
Lines of credit   63,529    0    0 
Other   13,415    0    0 
Credit card   0    0    0 
Residential   123,759    0    0 
Subtotal  $3,703,326   $34,223   $28,232 
                
With a related allowance recorded:               
Commercial  $112,394   $139   $139 
Commercial Real Estate:               
General   4,526,238    30,789    30,789 
Construction   0    0    0 
Consumer:               
Lines of credit   144,335    1,752    1,594 
Other   107,610    473    473 
Credit card   0    0    0 
Residential   509,502    4,237    4,237 
Subtotal  $5,400,079   $37,390   $37,232 
Total  $9,103,405   $71,613   $65,464 

 

- 21 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

   Six Months   Six Months   Six Months 
   Average Recorded   Interest Income   Cash Basis 
June 30, 2014  Investment   Recognized   Interest Recognized 
With no related allowance recorded:               
Commercial  $1,032,476   $15,036   $15,036 
Commercial Real Estate:               
General   4,176,059    114,817    103,651 
Consumer:               
Lines of credit   102,345    0    0 
Other   12,371    268    0 
Residential   411,666    0    0 
Subtotal  $5,734,917   $130,121   $118,687 
                
With a related allowance recorded:               
Commercial  $320,792   $8,182   $7,339 
Commercial Real Estate:               
General   4,562,707    0    0 
Consumer:               
Lines of credit   297,435    9,131    8,227 
Other   49,284    38    0 
Residential   651,645    13,100    12,351 
Subtotal  $5,881,863   $30,451   $27,917 
Total  $11,616,780   $160,572   $146,604 

 

- 22 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

   Six Months   Six Months   Six Months 
   Average Recorded   Interest Income   Cash Basis 
June 30, 2013  Investment   Recognized   Interest Recognized 
With no related allowance recorded:               
Commercial  $1,558,469   $21,221   $20,808 
Commercial Real Estate:               
General   2,383,298    52,308    46,841 
Construction   0    0    0 
Consumer:               
Lines of credit   86,625    0    0 
Other   18,510    0    0 
Credit card   0    0    0 
Residential   140,888    0    0 
Subtotal  $4,187,790   $73,529   $67,649 
                
With a related allowance recorded:               
Commercial  $422,999   $9,742   $9,387 
Commercial Real Estate:               
General   4,518,976    61,739    61,739 
Construction   0    0    0 
Consumer:               
Lines of credit   131,339    3,769    2,773 
Other   107,659    941    941 
Credit card   448    0    0 
Residential   489,844    8,428    8,428 
Subtotal  $5,671,265   $84,619   $83,268 
Total  $9,859,055   $158,148   $150,917 

 

- 23 -
 

 

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 June 30, 2014:

 

           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  $106,478   $0   $0   $106,478   $51,204,214   $51,310,692 
Commercial Real Estate:                              
General   318,055    0    0    318,055    53,723,689    54,041,744 
Construction   0    0    0    0    2,109,100    2,109,100 
Consumer:                              
Lines of credit   46,198    0    0    46,198    6,945,600    6,991,798 
Other   0    0    0    0    1,340,140    1,340,140 
Credit card   0    0    0    0    472,318    472,318 
Residential   0    0    0    0    14,045,675    14,045,675 
Total  $470,731   $0   $0   $470,731   $129,840,736   $130,311,467 

 

           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  $17,574   $41,339   $0   $58,913   $0   $58,913 
Commercial Real Estate:                              
General   0    0    184,720    184,720    2,121,457    2,306,177 
Construction   0    0    0    0    0    0 
Consumer:                              
Lines of credit   0    0    93,803    93,803    0    93,803 
Other   3,615    0    0    3,615    27,616    31,231 
Credit card   0    0    0    0    0    0 
Residential   0    0    93,482    93,482    128,498    221,980 
Total  $21,189   $41,339   $372,005   $434,533   $2,277,571   $2,712,104 

 

- 24 -
 

 

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, 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  $0   $0   $0   $0   $47,146,126   $47,146,126 
Commercial Real Estate:                              
General   0    0    0    0    54,827,857    54,827,857 
Construction   0    0    0    0    2,071,737    2,071,737 
Consumer:                              
Lines of credit   0    101,022    0    101,022    7,640,301    7,741,323 
Other   1,583    10,824    0    12,407    1,500,086    1,512,493 
Credit card   0    0    0    0    451,009    451,009 
Residential   62,333    2,241    0    64,574    15,098,466    15,163,040 
Total  $63,916   $114,087   $0   $178,003   $128,735,582   $128,913,585 

 

           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   $0   $0   $36,278   $36,278 
Commercial Real Estate:                              
General   0    0    0    0    2,375,592    2,375,592 
Construction   0    0    0    0    0    0 
Consumer:                              
Lines of credit   0    0    25,568    25,568    0    25,568 
Other   0    25,360    0    25,360    29,805    55,165 
Credit card   0    0    0    0    0    0 
Residential   97,482    0    224,185    321,667    167,740    489,407 
Total  $97,482   $25,360   $249,753   $372,595   $2,609,415   $2,982,010 

 

- 25 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

Troubled Debt Restructurings:

 

A loan is considered to be a Troubled Debt Restructure (“TDR”) when the Bank grants a concession to the borrower that it would not normally consider because the borrower is experiencing financial difficulty. The concession is typically a modification of one or more of the terms such as a rate reduction below the current market rate for new debt with similar risk; interest only payments on an amortizing note; a reduced payment amount which does not cover the interest; financing concessions; or a permanent reduction of the recorded investment of the loan.

 

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.

 

The Company has allocated $1,478,765 of specific reserves on $10,871,307 of unpaid principal balance of loans to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2014 and $1,539,865 on $8,452,163 of unpaid principal balance of loans as of December 31, 2013. At June 30, 2014, the Company had an additional $177,010 in performing loans outstanding to one of those customers. As of December 31, 2013, there was $180,557 committed to one customer.

 

The following tables present loans by class modified as troubled debt restructurings that occurred during the three and six month periods ended June 30, 2014:

 

       Pre-Modification   Post-Modification 
       Outstanding Recorded   Outstanding Recorded 
Three Months Ended June 30, 2014  Number of Loans   Investment   Investment 
Troubled Debt Restructurings:               
Commercial   1   $249,249   $275,116 
Commercial Real Estate:               
General   1    2,413,000    2,413,000 
Total   2   $2,662,249   $2,688,116 

 

       Pre-Modification   Post-Modification 
       Outstanding Recorded   Outstanding Recorded 
Six Months Ended June 30, 2014  Number of Loans   Investment   Investment 
Troubled Debt Restructurings:               
Commercial   1   $249,249   $275,116 
Commercial Real Estate:               
General   1    2,413,000    2,413,000 
Total   2   $2,662,249   $2,688,116 

 

In both the three and six month periods ending June 30, 2014 the modifications involved a financing concession on an amortizing note ranging from 4.5 months to 12 months.

 

- 26 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

In the three and six month periods ending June 30, 2014, there were no charge-offs related to the troubled debt restructurings however an additional $48,000 of specific reserves were established on existing troubled debt restructurings.

 

The following table presents loans by class modified as troubled debt restructurings that occurred during the three and six month periods ended June 30, 2013:

 

       Pre-Modification   Post-Modification 
       Outstanding Recorded   Outstanding Recorded 
Three Months Ended June 30, 2013  Number of Loans   Investment   Investment 
Troubled Debt Restructurings:               
Consumer:               
Lines of credit   2   $137,893   $137,893 
Total   2   $137,893   $137,893 

 

In the three month period ended June 30, 2013, there were no charge-offs as part of a troubled debt restructuring arrangement however, an additional $39,519 of specific reserves were established on one of the troubled debt restructurings.

 

       Pre-Modification   Post-Modification 
       Outstanding Recorded   Outstanding Recorded 
Six Months Ended June 30, 2013  Number of Loans   Investment   Investment 
Troubled Debt Restructurings:               
Commercial   1   $143,136   $133,425 
Consumer:               
Lines of credit   2    137,893    137,893 
Total   3   $281,029   $271,318 

 

In the six month period ended June 30, 2013, one modification involved a stated interest rate below the current market rate for a period of 7 years, while another modification involved interest only payments for 2.5 yearson an amortizing note. One A-B note modification involved a permanent reduction of the recorded investment in the loan.

 

In the six month period ended June 30, 2013 there were $9,711 of charge-offs as part of a troubled debt restructuring arrangement and an additional $39,519 of specific reserves established.

 

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

 

For the three and six month periods ending June 30, 2013 there were no troubled debt restructurings that experienced a payment default within 12 months following the modification. For the three and six month periods ended June 30, 2014 there was one troubled debt restructuring that experienced a payment default within 12 months following the modification. The payment default occurred in the second quarter. Below is a table which presents that loan by class:

 

- 27 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

       Recorded Investment 
   Number of Loans   at time of default 
Troubled Debt Restructurings          
That Subsequently Defaulted:          
Commercial   1   $196,340 
Total   1   $196,340 

 

The troubled debt restructuring that subsequently defaulted described above did not result in any additional charge-offs and there were no specific reserves on the remaining balance as of June 30, 2014.

 

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 analyzed once a quarter to assess the borrower’s 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 in full.

 

- 28 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

As of June 30, 2014 and December 31, 2013, 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 
   June 30,   December 31,   June 30,   December 31,   June 30,   December 31, 
   2014   2013   2014   2013   2014   2013 
1  $33,194   $0   $0   $0   $0   $0 
2   0    94,676    0    0    0    0 
3   10,115,950    8,623,409    6,000,200    5,524,989    0    0 
4   13,844,919    13,898,810    18,735,484    18,675,411    383,085    441,114 
5   20,828,862    17,539,364    19,194,922    20,604,611    330,054    233,302 
5M   3,301,810    4,255,639    4,503,675    5,114,931    1,395,961    1,397,321 
6   2,175,604    1,699,009    5,607,820    4,908,058    0    0 
7   1,051,617    1,052,903    0    229,576    0    0 
8   17,649    18,594    2,305,820    2,145,873    0    0 
Total  $51,369,605   $47,182,404   $56,347,921   $57,203,449   $2,109,100   $2,071,737 

 

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 June 30, 2014 and December 31, 2013:

 

   Residential 
   June 30,   December 31, 
   2014   2013 
Performing  $13,406,130   $14,524,492 
Impaired   861,525    1,127,955 
Total  $14,267,655   $15,652,447 

 

   Consumer – Lines of credit   Consumer – Other   Consumer – Credit card 
   June 30,   December 31,   June 30,   December 31,   June 30,   December 31, 
   2014   2013   2014   2013   2014   2013 
Performing  $6,696,552   $7,363,137   $1,339,573   $1,452,984   $472,318   $451,009 
Impaired   389,049    403,754    31,798    114,674    0    0 
Total  $7,085,601   $7,766,891   $1,371,371   $1,567,658   $472,318   $451,009 

 

- 29 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

5.FORECLOSED ASSETS

 

Foreclosed asset activity at June 30:

 

   June 30,   June 30, 
   2014   2013 
Beginning of year  $2,558,299   $2,806,781 
Additions   229,837    582,024 
Reductions from sales   (219,500)   (449,290)
Direct write-downs   (70,028)   (108,740)
End of period  $2,498,608   $2,830,775 
           
Expenses related to foreclosed assets include:          
Operating expenses, net of rental income  $101,201   $106,572 

 

6.PREMISES AND EQUIPMENT

 

Period end premises and equipment were as follows at June 30, 2014 and December 31, 2013:

 

   June 30,   December 31, 
   2014   2013 
Land & land improvements  $4,700,464   $4,700,464 
Buildings & building improvements   6,201,507    6,201,507 
Furniture, fixtures and equipment   3,872,254    3,864,940 
    14,774,225    14,766,911 
Less:  accumulated depreciation   5,626,153    5,621,444 
   $9,148,072   $9,145,467 

 

- 30 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

7.DEPOSITS

 

The components of the outstanding deposit balances at June 30, 2014 and December 31, 2013 were as follows:

 

   June 30,   December 31, 
   2014   2013 
Non-interest-bearing DDA  $33,285,926   $33,313,136 
Interest-bearing DDA   31,336,888    24,861,560 
Money market   21,378,508    19,202,665 
Savings   10,572,371    10,214,719 
Time, under $100,000   70,448,424    74,352,652 
Time, over $100,000   10,000,390    9,995,133 
Total Deposits  $177,022,507   $171,939,865 

 

There were no brokered deposits at either June 30, 2014 or December 31, 2013. Since the Bank was not categorized as “well capitalized” at June 30, 2014 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 consisted entirely of repurchase agreements in 2014 and 2013. Information regarding repurchase agreements at June 30, 2014 and December 31, 2013 is summarized below:

 

   Repurchase 
   Agreements 
     
Outstanding at June 30, 2014  $10,020,151 
Average interest rate at period end   0.52%
Average balance during period   8,809,976 
Average interest rate during period   0.54%
Maximum month end balance during period   10,046,290 
      
Outstanding at December 31, 2013  $8,428,046 
Average interest rate at year-end   0.56%
Average balance during year   9,706,847 
Average interest rate during year   0.58%
Maximum month end balance during year   10,878,256 

 

- 31 -
 

 

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 $3,125,808. 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 carrying value of $7,627,312 pledged at June 30, 2014 and $3,709,600 pledged at year-end 2013. The Bank had no outstanding borrowings with the FHLB at either June 30, 2014 or December 31, 2013.

 

At June 30, 2014, the Bank used a portion of the residential loans pledged to the Federal Home Loan Bank to collateralize a $2,000,000 overdraft line of credit. At June 30, 2014, there was no balance outstanding on the line of credit.

 

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 2.28% at June 30, 2014 and 2.30% at December 31, 2013. 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 end of the allowable deferral period will be March 31, 2015. The accrued interest payable on the subordinated debentures was $502,651 at June 30, 2014, and $444,042 at December 31, 2013 and is included in accrued expenses and other liabilities on the consolidated balance sheets at June 30, 2014 and December 31, 2013.

 

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.

 

- 32 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

11.NOTES PAYABLE

 

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, Gary F. Bogner, Robert L. Chandonnet and Bruce J. Essex, one former director and five local businessmen. On the same day, $500,000 of the proceeds were used to settle, in full, a defaulted debt with a financial institution[1]. The remaining proceeds of the senior debt are being 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 June 30, 2014 was approximately $26,000. The entire interest balance due was paid on July 1, 2014.

 

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 June 30, 2014 and December 31, 2013 follows:

 

   June 30, 2014   December 31, 2013 
         
Unused lines of credit and letters of credit  $22,530,937   $22,576,236 
Commitments to make loans   0    243,721 

 

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.

 

 

1 The book value of the liability was $5,763,000 resulting in a gain of $5,263,000 which appears in the condensed consolidated statement of income as a gain on extinguishment of debt.

 

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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. An asset or liability’s placement in the hierarchy is based on the lowest level of input that is significant to the fair value estimate. 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.

 

- 34 -
 

 

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.

 

- 35 -
 

 

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 June 30, 2014 and December 31, 2013:

 

       Fair Value Measurements Using 
       Quoted Prices   Significant     
       in Active   Other   Significant 
       Markets for   Observable   Unobservable 
       Identical Assets   Inputs   Inputs 
   Total   (Level 1)   (Level 2)   (Level 3) 
June 30, 2014                    
Available for sale securities:                    
US Treasury  $2,538,125   $2,538,125   $0   $0 
US Government and federal agency   14,297,553    0    14,297,553    0 
Municipals   1,074,934    0    1,074,934    0 
Mortgage-backed and collateralized mortgage obligations– residential   13,337,989    0    13,337,989    0 
Total  $31,248,601   $2,538,125   $28,710,476   $0 
                     
Servicing assets  $34,699   $0   $34,699   $0 
                     
December 31, 2013                    
Available for sale securities:                    
US Treasury  $2,542,032   $2,542,032   $0   $0 
US Government and federal agency   15,867,406    0    15,867,406    0 
Municipals   1,591,141    0    1,591,141    0 
Mortgage-backed and collateralized mortgage obligations– residential   11,229,667    0    11,229,667    0 
Total  $31,230,246   $2,542,032   $28,688,214   $0 
                     
Servicing assets  $37,217   $0   $37,217   $0 

 

There were no transfers between levels during the second quarter of 2014 or 2013.

 

- 36 -
 

 

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 for the periods ended June 30, 2014 and December 31, 2013:

 

       Quoted Prices in
Active Markets for
Identical Assets
   Significant
Other Observable
Inputs
   Significant
Unobservable Inputs
 
   Total   (Level 1)   (Level 2)   (Level 3) 
June 30, 2014                    
Impaired loans1:  6,746,860   $0   $0   $6,746,860 
Foreclosed assets:   2,498,608    0    0    2,498,608 
Total  9,245,468   $0   $0   $9,245,468 

 

       Quoted Prices in
Active Markets for
Identical Assets
   Significant
Other Observable
Inputs
   Significant
Unobservable Inputs
 
   Total   (Level 1)   (Level 2)   (Level 3) 
December 31, 2013                    
Impaired loans1:  6,645,389   $0   $0   $6,645,389 
Foreclosed assets:   2,558,299    0    0    2,558,299 
Total  9,203,688   $0   $0   $9,203,688 

 

 

1 Collateral dependent

 

- 37 -
 

 

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 June 30, 2014 
   Carrying                 
   Amount   Level 1   Level 2   Level 3   Total 
   (in thousands) 
Financial assets                         
Cash and cash equivalents  $23,077   $23,077   $0   $0   $23,077 
Loans held for sale   111    0    113    0    113 
Loans, net (including impaired)   129,962    0    0    125,799    125,799 
FHLB stock   451     N/A      N/A      N/A      N/A  
Accrued interest receivable   434    8    106    320    434 
                          
Financial liabilities                         
Deposits   177,023    89,998    80,800    0    170,798 
Federal funds purchased and                         
repurchase agreements   10,020    0    10,020    0    10,020 
Subordinated debentures   4,500    0    0    1,125    1,125 
Notes payable   1,280    0    0    1,280    1,280 
Accrued interest payable   563    4    31    152    187 

 

       Fair Value Measurements 
       at December 31, 2013 
   Carrying                 
   Amount   Level 1   Level 2   Level 3   Total 
   (in thousands) 
Financial assets                         
Cash and cash equivalents  $17,133   $17,133   $0   $0   $17,133 
Loans held for sale   240    0    246    0    246 
Loans, net (including impaired)   128,745    0    0    122,235    122,235 
FHLB stock   451     N/A      N/A      N/A      N/A  
Accrued interest receivable   467    8    117    342    467 
                          
Financial liabilities                         
Deposits   171,940    79,596    84,785    0    164,381 
Federal funds purchased and                         
repurchase agreements   8,428    0    8,428    0    8,428 
Subordinated debentures   4,500    0    0    1,125    1,125 
Notes payable   1,280    0    0    1,280    1,280 
Accrued interest payable   506    4    32    137    173 

 

- 38 -
 

 

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) 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.

 

(c) FHLB stock

 

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

 

(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.

 

- 39 -
 

 

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, the Company considers 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. Consequently, the Company determined it is necessary to carry a valuation allowance against our entire net deferred tax asset each reporting period since 2009.

 

The realization of the Company’s deferred tax assets is largely dependent upon the ability to generate future income. Although the Company recognized a profit in 2012, 2013 and the first half of 2014, there must be a consistent trend of operational profitability in order to support the realization of deferred tax assets. The full valuation allowance against 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. The Company 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 in 2013, the Company recorded income tax expense from operations in the amount of $105,000. This amount represented projected taxable earnings subject to alternative minimum taxation which may fluctuate in future periods with changes in operating results.

 

There were no unrecognized tax benefits at June 30, 2014 and December 31, 2013, and the Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next 12 months.

 

As of December 31, 2013, the Company has a net operating loss carry-forward of $7,466,000 to be utilized to offset future taxable income that will begin expiring in 2029.

 

The Company was subject to a State of Michigan, Department of Treasury, Michigan Business Tax Audit for the fiscal years of 2008 through 2011. On April 3, 2014, the Company was officially notified that there was no discrepancy found in its reported tax liability.

 

- 40 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

15.REGULATORY MATTERS

 

Banks are subject to regulatory capital requirements administered by the federal banking agencies. Since the Company is a one bank holding company with consolidated assets less than $500 million, regulatory minimum capital ratios are applied only to the Bank. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet various capital requirements can initiate regulatory action.

 

Prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If a bank is not well capitalized, regulatory approval is required to accept brokered deposits. Subject to limited exceptions, a bank may not make a capital distribution if, after making the distribution, it would be undercapitalized. If a bank is undercapitalized, it is subject to being closely monitored by its principal federal regulator, its asset growth and expansion are restricted, acquisitions, new activities, new branches, payment of dividends or management fees are prohibited and plans for capital restoration are required. In addition, further specific types of restrictions may be imposed on the Bank at the discretion of the federal regulator.

 

The Bank was in the adequately capitalized category at both June 30, 2014 and December 31, 2013.

 

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 June 30, 2014 and December 31, 2013 were:

 

           Minimum Required   Minimum Required 
           For Capital   Under 
   Actual   Adequacy Purposes   Consent Order 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
                         
June 30, 2014                        
Total Capital (Tier 1 and Tier 2) to risk-weighted assets of the Bank  $11,828,664    8.52%  $11,106,456    8.00%  $15,271,377    11.00%
Tier 1 (Core) Capital to risk-weighted assets of the Bank   10,080,858    7.26    5,553,228    4.00    N/A    N/A 
Tier 1 (Core) Capital to average assets of the Bank   10,080,858    5.09    7,924,648    4.00    16,839,876    8.50 

 

- 41 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

15.REGULATORY MATTERS (Continued)

 

           Minimum Required   Minimum Required 
           For Capital   Under 
   Actual   Adequacy Purposes   Consent Order 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
                         
December 31, 2013                        
Total Capital (Tier 1 and Tier 2) to risk-weighted assets of the Bank  $11,420,073    8.48%  $10,769,246    8.00%  $14,807,713    11.00%
Tier 1 (Core) Capital to risk-weighted assets of the Bank   9,723,466    7.22    5,384,623    4.00    N/A    N/A 
Tier 1 (Core) Capital to average assets of the Bank   9,723,466    5.24    7,423,426    4.00    15,774,781    8.50 

 

Federal Reserve guidelines limit the amount of allowance for loan losses that can be included in Tier 2 capital. In general only 1.25% of net risk-weighted assets are allowed to be included. At June 30, 2014, only $1,747,806 was counted as Tier 2 capital and $993,754 was disallowed. At December 31, 2013, $1,696,607 was counted as Tier 2 capital and $1,113,035 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; to develop an analysis and assessment of the Bank's management needs and action plans for classified loans. All of these required items were completed. The only outstanding directive under the Consent Order is attaining the requested capital levels.

 

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 June 30, 2014 or December 31, 2010, 2011, 2012 or 2013. Management continues to explore options to raise the capital required for full compliance. At June 30, 2014, a capital contribution of $6,759,000 would have been needed to meet the capital ratios specified in the Consent Order.

 

- 42 -
 

 

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

15.REGULATORY MATTERS (Continued)

 

The Bank continues to work in cooperation with its regulators; however the ability to fully comply with the specified capital levels, is not entirely within the Company’s control, and is not assured due to the availability of capital or other funds and actions taken by regulators. Failure to comply with provisions of the Consent Order may result in further regulatory action that could have a material adverse effect on the Company and its shareholders, as well as the Bank. As long as the Consent Order remains, 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.

 

- 43 -
 

 

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 June 30, 2014 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 June 30, 2014 to that at December 31, 2013. The part labeled Results of Operations discusses the three month and six month periods ending June 30, 2014 as compared to the same periods of 2013. 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 or Written Agreement 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.

 

The Company has returned to profitability but the overall banking environment remains challenging particularly from an interest rate standpoint. Economic indicators appear to be getting better. Locally, unemployment rates are declining but definitely remain at elevated levels. At June 30, 2014, unemployment was 7.4% for Muskegon County and 5.8% for Ottawa County which is better than unemployment rates of 9.2% for Muskegon County and 7.2% for Ottawa County at June 30, 2013. Additionally, local property values are generally holding and in some areas increasing.

 

- 44 -
 

 

COMMUNITY SHORES BANK CORPORATION

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

 

Although these signs of progress in the economic climate are encouraging, the effects of the extended downturn from 2007 through 2011 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, as detailed below under the caption “Regulatory Matters.”.

 

In management’s view the most pressing issue confronting the Company is the need for additional capital or modification of the terms of existing senior debt. As of June 30, 2014, the Company’s has a cash balance of approximately $435,000, which at present is the Company’s only assured source of liquidity due to the regulatory constraints on the Bank’s ability to declared dividends, as described below under the caption “Regulatory Matters.” Despite the improved health of the Bank, in order to remain solvent beyond the first quarter of 2015, The Company will require an infusion of capital prior to the maturity of its senior debt on March 31, 2015 (See Note 11 to the Company’s Consolidated Financial Statements for additional details) e end of the allowable deferral period on its subordinated debentures and associated trust preferred securities on June 30, 2015 (see Note 10 to the Company’s Consolidated Financial Statements for additional details). Management and the Board of Directors are actively seeking financing alternatives, including an infusion of capital or a modification, expansion and extension of the senior debt. Nonetheless, we cannot be certain that we will be successful in these efforts, or we will be able to obtain the required capital or extension of credit.

 

REGULATORY MATTERS

 

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 June 30, 2014.

 

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 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. At present, the Company’s sole liquidity resource is its cash account balance which, as of June 30, 2014, was approximately $435,000.

 

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COMMUNITY SHORES BANK CORPORATION

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

 

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

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES: The “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as disclosures found elsewhere in this Form 10-Q 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. The allowance for loan losses, income taxes and foreclosed assets are deemed critical due to the required level of management judgment and the use of estimates that are particularly susceptible to significant change in the near term.

 

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 4 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.

 

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 results. 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.

 

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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.

 

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company had no unrecognized tax positions at either June 30, 2014 or December 31, 2013.

 

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 or instead of loan foreclosure 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 the Company’s books.

 

FINANCIAL CONDITION

 

Total assets were $197.9 million at June 30, 2014 compared to $190.8 million at December 31, 2013. Asset growth occurring in the first six months of 2014 stemmed from increases to customer deposit accounts, which in turn drove up the Company’s balance on deposit at the FRB and to a lesser extent provided funding for loan growth.

 

Cash and cash equivalents increased by $6.0 million to $23.1 million at June 30, 2014 from $17.1 million at December 31, 2013. The Bank’s FRB balance increased by $5.0 million from year-end 2013 and was $18.3 million on June 30, 2014. The increase in balance was driven largely by an increase in customer deposit balances. 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 events. The excess funds are expected to be used to fund loans and to repay upcoming time deposit maturities.

 

The Bank’s security portfolio was $31.2 million at both June 30, 2014 and December 31, 2013. Investment activity in the first six months of the year consisted of maturities, prepayments and calls totaling $4.1 million, purchases totaling $4.7 million and one security sale for $661,000. The sale resulted in a gain of roughly $7,400. The security was sold because it no longer met the criteria of the Bank’s Investment Policy.

 

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COMMUNITY SHORES BANK CORPORATION

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

 

The securities portfolio is a key source of liquidity for the Bank. Given the Bank’s regulatory standing, off-balance-sheet borrowing facilities are significantly limited, forcing the Bank to resort to on-balance-sheet sources. Accordingly, 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 or saleable securities is one of the driving forces behind investment activity. Typically the Bank aims to leave between 10% and 20% of its investment portfolio unpledged. At June 30, 2014, 16% of the investment portfolio was unencumbered. This outcome is close to the 15% unpledged position that existed on December 31, 2013.

 

At June 30, 2014, securities with an amortized cost of $26.1 million were pledged to public fund customers, the FRB discount window and customer repurchase agreements.

 

Investment portfolio quality has received much scrutiny over the past several years. The value of the portfolio is impacted by national and global economic news. During the first six months of 2014, the investment portfolio went from a net unrealized loss to a net unrealized gain position. The $194,000 change in value was made up of a $201,000 unrealized gain offset by $7,000 of realized gain. Although the portfolio had a net unrealized gain position of $126,000 at June 30, 2014, there were 20 securities with an amortized cost of $12.6 million having an unrealized loss of $124,000; 12 of the 20 had an unrealized loss longer than 12 months.

 

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 June 30, 2014.

 

Loans held for sale activity during the first six months of 2014 included $2.3 million of loan originations and $2.5 million of loan sales. The associated gain on the loan sales was $65,000. There were $111,000 of loans held for sale at June 30, 2014 and $240,000 held for sale at December 31, 2013. Mortgage loan activity was believed to be negatively affected by the harsh weather in the first three months of 2014. Activity picked up in the second quarter of 2014 but continues to be less than that of the previous year.

 

Total loans (held for investment) increased $1.1 million and were $132.7 million at June 30, 2014 up from $131.6 million at December 31, 2013. Increases in the commercial and commercial real estate portfolios were largely offset by decreases in nearly every other loan category. At June 30, 2014, the concentration of commercial and commercial real estate loans was 83%; up from a level of 81% at year-end 2013. The outcome is in line with the Bank’s wholesale focus which has been maintained since opening in 1999. Improvement in wholesale lending activity supports management’s belief that the local economy has stabilized substantially and is in fact growing.

 

Credit quality remains a priority of the Company. The lending staff diligently monitors the loan portfolio and adheres to a well-designed credit risk assessment process. Nonetheless, the Bank is still exposed to credit risk. 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.

 

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COMMUNITY SHORES BANK CORPORATION

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

 

The Bank has developed a detailed process to estimate credit risk. The process is discussed at length in Note 1 to the Company’s 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 three portions: general credit allocations, specific credit allocations and unallocated. 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. Specifically identified loans are individually evaluated for impairment.

 

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 either a collateral analysis or a present value of cash flow analysis that supports a loan loss reserve allocation of zero.

 

At June 30, 2014, the allowance for loan losses totaled $2.7 million. At year-end 2013, the allowance for loan losses was $2.8 million. The ratio of allowance to gross loans outstanding decreased to a level of 2.07% at June 30, 2014 compared to 2.14% at year-end 2013.

 

The allocation of the allowance at June 30, 2014 and December 31, 2013 was as follows:

 

   June 30, 2014   December 31, 2013 
       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  428,247    38.6%  339,048    35.7%
Commercial Real Estate   1,468,382    44.0    1,713,193    45.0 
Consumer   390,000    6.7    424,824    7.4 
Residential   229,779    10.7    227,767    11.9 
Unallocated   225,152    N/A    104,810    N/A 
Total  2,741,560    100.0%  2,809,642    100.0%

 

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COMMUNITY SHORES BANK CORPORATION

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

 

The general component of the allowance for loan losses as a percentage of non-specifically identified loans was 0.81% at June 30, 2014, a decrease of 8 basis points from year-end 2013. At year-end 2013, the general component of the allowance for loan losses was 0.89% of total non-specifically identified loans. Management feels that the trend of the general component of the allowance for loan losses is in line with improvement in the local economy, local unemployment and the overall improvement in the credit quality of the loan portfolio.

 

At June 30, 2014, there was $225,000 of unallocated reserves in the allowance for loan losses. Unallocated reserves were $105,000 at December 31, 2013. The increase of $120,000 stemmed primarily from a large recovery of a previously charged off loan. The recovery occurred in the first quarter of 2014.

 

At June 30, 2014, the allowance contained $1.5 million in specific allocations for impaired loans whereas at December 31, 2013 there was $1.6 million specifically allocated. There was $11.7 million of recorded investment on impaired loans at June 30, 2014 compared to $9.6 million at year-end 2013. The increase stemmed from a large relationship that was impaired during the first quarter of 2014 in a troubled debt restructure transaction. The relationship totaled $2.7 million.

 

Not all specifically identified loans require an allocation of reserves. In many cases, specifically identified loans have charge-offs since the time of their initial impairment, which reduces principal to the current value of assigned collateral or expected repayment, therefore no further reserve is required. Specifically identified loans requiring no reserves rose to 71% of the recorded investment of total specifically identified loans at June 30, 2014; up from 24% at year-end 2013. At June 30, 2014, the recorded investment on impaired loans requiring no reserves was $8.4 million, an increase of $6.1 million since year-end 2013. Three relationships were responsible for the change. One impaired relationship for $1.6 million required a specific allocation at year-end 2013 but none at March 31, 2014. During the first three months of 2014, the borrower payments reduced principal enough to remove the allocation. The specific allocation associated with the loan was $7,000 at year-end 2013. The second relationship increasing this category was the $2.7 million TDR transaction mentioned above. The third impaired relationship’s recorded investment was $2.2 million and had a specific allocation of $193,000 at year-end 2013. In 2014’s second quarter, the Bank charged off the specific allocation associated with this credit which had been reduced to $164,000. On July 10, 2014, the remaining balance of the loan was paid in full.

 

Recorded investment on specifically identified loans requiring reserves was $3.4 million at June 30, 2014 compared to $7.3 million at year-end 2013. The $3.9 million decrease in recorded investment stemmed from two of the impaired relationships noted above that no longer required reserves; one due to principal repayment in the first months of the year and the other because of the charge-off taken in the second quarter of the year.

 

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 2013 to June 30, 2014, the recorded investment in accruing past due and non-accrual loans increased by $23,000. This was evidenced by a $293,000 increase in the recorded investment in past due loans and a $270,000 decrease in the recorded investment in non-accrual loans since year-end 2013.

 

The recorded investment of accruing loans past due 30-59 days was $470,000 at June 30, 2014; an increase of $407,000 since December 31, 2013. There were three loans past due 30-59 days at June 30, 2014. One of the loans was paid current in July. The biggest loan, totaling $315,000, was placed on non-accrual in July. The guarantor has filed bankruptcy and the Bank is working with the Bankruptcy Court Trustee to evaluate the real estate collateral associated with the loan.

 

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COMMUNITY SHORES BANK CORPORATION

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

 

There were no accruing loans past due 60-89 days at June 30, 2014. At December 31, 2013 the recorded investment of accruing loans past due 60-89 days was $114,000. One loan past due 60-89 days at year-end is now in the 30-59 day past due category; one loan resulted in a $32,000 charge-off and two small loans were paid in full in the first six months of the year.

 

There were no accruing loans with a recorded investment past due 90 days and greater at either June 30, 2014 or year-end 2013.

 

Although the amount of past due loans has increased compared to prior periods, the increase is essentially related to two credits one of which is now current. The credit review process will continue to be stringent; however, it is possible that past dues could fluctuate further in future periods.

 

Non-accrual loans totaled $2.7 million at June 30, 2014 and $3.0 million at year-end 2013. No non-accrual notes are secured by undeveloped real estate. At June 30, 2014, there were specific allocations of $1.1 million in the allowance for any estimated collateral deficiency on non-accrual loans.

 

The Bank had net charge-offs of $301,000 in the second quarter of 2014 and net charge offs of $68,000 for the first six months of the year. More than 50% of the second quarter charge-offs were related to the $163,000 specific allocation on the impaired loan mentioned earlier. Year-to-date net charge-offs are lower than the total for the second quarter alone due to a $250,000 recovery recorded in the first quarter when the Bank prevailed in a lawsuit related to a previously charged off credit. The ratio of annualized net charge-offs to average loans was 0.90% for the second quarter of 2014 while the ratio of net charge-offs to average loans was 0.10% for the first six months of 2014.

 

The net charge-offs for the second quarter of 2013 were $15,000 and $96,000 for the first half of 2013. The resulting ratio of net charge-offs to average loans for the second quarter of 2013 was 0.05% and 0.15% for the first six months of the same year.

 

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 risk[1].

 

 

1Extension risk, as related to loans, exists when booking fixed rate loans with long final contractual maturities. When a customer is contractually allowed longer to return its borrowed principal and rates rise, the Bank is delayed from taking advantage of the opportunity to reinvest the returning principal at the higher market rate.

 

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COMMUNITY SHORES BANK CORPORATION

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

 

The loan maturities and rate sensitivity of the loan portfolio at June 30, 2014 are set forth below:

 

   Within   Three to   One to   After     
   Three Months   Twelve Months   Five Years   Five Years   Total 
Commercial  $7,052,392   $15,783,466   $20,625,431   $7,756,760   $51,218,049 
Commercial Real Estate:                         
General   4,170,351    7,931,878    38,140,422    6,016,113    56,258,764 
Construction   0    1,487,536    615,908    0    2,103,444 
Consumer:                         
Lines of credit   412,141    203,836    2,464,313    3,979,254    7,059,544 
Other   56,038    59,374    745,421    504,789    1,365,622 
Credit card   53,379    165,407    253,532    0    472,318 
Residential   0    258,725    0    13,966,773    14,225,498 
   $11,744,301   $25,890,222   $62,845,027   $32,223,689   $132,703,239 
Loans at fixed rates  $7,087,147   $13,587,883   $48,445,530   $25,271,077   $94,391,637 
Loans at variable rates   4,657,154    12,302,339    14,399,497    6,952,612    38,311,602 
   $11,744,301   $25,890,222   $62,845,027   $32,223,689   $132,703,239 

 

At June 30, 2014, there were 71% of the loan balances carrying a fixed rate and 29% 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 been 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. At June 30, 2014, approximately 24% of the entire loan portfolio had a contractual maturity longer than five years; down from 26% at year-end 2013. 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, it has been shown that loans of this type do not generally 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 of loans that are booked into the held for investment portfolio.

 

Foreclosed assets were $2.5 million at June 30, 2014, which was a decrease of $60,000 since December 31, 2013. These assets consist of relinquished properties through the collection process which were previously customer collateral supporting various borrowings. There were four lot and four property sales during the first six months of 2014 and four properties were added. There were net gains on the sales of $91,000. At June 30, 2014, foreclosed assets consisted of 23 real estate holdings, the same as at December 31, 2013.

 

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COMMUNITY SHORES BANK CORPORATION

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

 

Deposit balances were $177.0 million at June 30, 2014 up from $171.9 million at December 31, 2013. The increase stemmed from interest-bearing demand deposits increasing by $6.5 million, money market balances increasing by $2.2 million; the sum of which was partially offset by a $3.9 million decrease in the time deposit portfolio since year-end 2013. Over 70% of the increase in interest-bearing checking balances is from additional funds on deposit by the Bank’s leading public fund customers. Over 40% of the increase in money market balances is from a customer relationship transferring from a demand deposit account to a money market account and the rest is from an increase in the balances of a few public fund customers. Management made a deliberate effort to contract the time deposit during the first half of the year in an effort to reduce excess liquidity at the FRB.

 

Repurchase agreement balances were $10.0 million at June 30, 2014 and $8.4 million at December 31, 2013; an increase of $1.6 million. The increase between the two period ends was primarily the result of several existing customers increasing their balance since year-end 2013.

 

Shareholders’ equity was approximately $4.1 million on June 30, 2014. On December 31, 2013, the balance was $3.7 million. The net increase of $391,000 was made up of net income recorded in the first six months of 2014 and an increase in accumulated other comprehensive income (security market value adjustments). The book value per share was $2.76 at June 30, 2014.

 

The Bank’s total risk-based capital ratio rose since year-end 2013. At June 30, 2014, the Bank’s total risk-based capital ratio was 8.52%. The Bank’s total risk-based capital ratio at December 31, 2013 was 8.48%. Its tier one to average assets ratio declined 15 basis points and was 5.09% at June 30, 2014 compared to 5.24% at year-end 2013. The total risk-based capital ratio improved because of the Bank’s earnings recorded in the first half of 2014. The tier one to average assets ratio declined since year-end 2013 due to the liquidity fluctuation increasing the Bank’s FRB account. The Bank was considered adequately capitalized according to prompt corrective action regulation at both June 30, 2014 and December 31, 2013.

 

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 June 30, 2014. In order to attain the level of capital required by the Consent Order, the Bank would have needed additional capital of $6,759,000 on June 30, 2014 based on its asset mix and size. This is $708,000 more than the $6,051,000 that would have been needed on December 31, 2013. The increase in average assets since year-end 2013 increased the capital need.

 

RESULTS OF OPERATIONS

 

Net income recorded for the first half of 2014 was $213,000; $5.2 million less than net income recorded for the similar period in 2013. The income recorded in the first six months of 2013 stemmed mainly from a $5.3 million gain on debt extinguishment. The corresponding basic and diluted earnings per share for the first six months of 2014 was $0.14. The basic and diluted earnings per share for the first six months of 2013 was $3.66; $3.58 per share of which was attributable to the aforementioned gain on the debt extinguishment.

 

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COMMUNITY SHORES BANK CORPORATION

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

 

Net income for the second quarter of 2014 was $102,000, which was $27,000 more than net income of $75,000 recorded for the second quarter of 2013. The corresponding basic and diluted earnings per share for the second quarter of 2014 was $0.07. The basic and diluted earnings per share for the second quarter of 2013 was $0.05.

 

For the first six months of 2014, the annualized return on the Company’s average total assets was 0.22% compared to 5.41% for the first six months of 2013. The annualized return on the Company’s average total assets was greatly impacted by the aforementioned gain on the debt extinguishment occurring in 2013’s first quarter. For the second quarter of 2014, the annualized return on the Company’s average total assets was 0.21%. For the second quarter of 2013, the annualized return on the Company’s average assets was 0.15%.

 

For the first half of 2014, the annualized return on the Company’s average equity was 10.88%. For the second quarter of 2014, the annualized return on the Company’s average equity was 10.27%. The Company’s average shareholders’ equity became positive in the first quarter of 2013 after recording the $5.3 million debt extinguishment gain on March 20, 2013. The low equity average and the high net income greatly inflated the annualized return on equity results for 2013. For the first six months of 2013, the annualized return on shareholders’ equity was 624.49%. Since the average equity was positive for the entire second quarter of 2013, the annualized return on shareholders’ equity results were normalized at a level of 7.74%.

 

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COMMUNITY SHORES BANK CORPORATION

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

 

A primary component of the Company’s revenue is its net interest income. The Company’s net interest income was less for the first half of 2014 compared to the similar period in 2013 and the net interest margin was lower. 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.

 

   Six Months ended June 30, 
   2014   2013 
   Average       Average   Average       Average 
   Balance   Interest   Rate   Balance   Interest   Rate 
Assets                              
Federal funds sold and interest- bearing deposits with banks  $19,168,887   $23,342    0.24%  $15,403,645   $18,313    0.24%
Securities   30,786,777    229,193    1.49    39,130,885    294,599    1.51 
Loans (including held for sale and non accrual)   132,934,642    3,435,813    5.17    131,449,876    3,591,366    5.46 
Total interest earning assets   182,890,306    3,688,348    4.03    185,984,406    3,904,278    4.20 
Other assets   12,849,633              12,937,183           
   $195,739,939             $198,921,589           
Liabilities and Shareholders’ Equity                              
Interest-bearing deposits  $142,257,143   $425,606    0.60%  $143,665,307   $531,050    0.74%
Repurchase agreements   8,809,976    23,967    0.54    10,043,572    29,726    0.59 
Subordinated debentures and notes payable   5,780,000    110,094    3.81    5,228,398    88,038    3.37 
Total interest bearing liabilities   156,847,119    559,667    0.71    158,937,277    648,814    0.82 
Non-interest-bearing deposits   34,206,280              35,032,523           
Other liabilities   771,958              3,229,250           
Shareholders’ Equity   3,914,582              1,722,539           
   $195,739,939             $198,921,589           
Net interest income        3,128,681              3,255,464      
Net interest spread on earning assets             3.32%             3.38%
Net interest margin on earning assets             3.42%             3.50%
Average interest-earning assets to average interest-bearing liabilities             116.60%             117.02%

 

The net interest spread on average earning assets decreased 6 basis points to 3.32% in the past twelve months. The net interest margin decreased by 8 basis points from 3.50% for the first six months of 2013 to 3.42% for the first six months of 2014. The net interest income for the first six months of 2014 was $3.1 million compared to a figure of $3.3 million for the same six months in 2013. Additionally, there was a decrease in average earning assets of $3.1 million when comparing the first half of 2014 to the first half of 2013. As a result of having less net interest income and fewer average earning assets, the net interest margin declined. The erosion stemmed primarily from a 17 basis point reduction in the average rate earned on the Company’s earning assets. The decrease was partially offset by an 11 basis point reduction in the yield paid on interest bearing liabilities.

 

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COMMUNITY SHORES BANK CORPORATION

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

 

The average rate earned on interest earning assets was 4.03% for the six month period ending June 30, 2014 compared to 4.20% for the same period in 2013. The decline was caused by both rate and earning asset composition differences. The average rate earned on deposits at other financial institutions and the securities portfolio remained similar for both periods however, the concentration of these earning assets was different. In 2013’s first half there were more securities and a lower balance on deposit at other financial institutions. In addition to these differences, there was a reduction in the yield on the loan portfolio, the Company’s largest earning asset category. The average rate earned on the loan portfolio was 5.17% in the first half of 2014, a reduction of 29 basis points compared to the first half of 2013. As the credit markets recover, financial institutions are more actively soliciting new business making the rate environment more competitive. In order to attract new customers and retain current ones, sometimes the Bank has to offer rates that are lower than the average portfolio rate. Each rate decision takes into consideration the quality of the loan from an underwriting standpoint. Lower rates are not being automatically offered on renewals or new business. Lower rates are used selectively based on the risk characteristics of the credit.

 

Decreases to the overall yield on interest earning assets were partially offset by rate reductions on the funding side. Over the past twelve months, the cost of funds improved 11 basis points. The main contributing factor was a 14 basis point improvement in the rate paid on interest bearing deposits when comparing the first six months of 2014 to that of the similar period of 2013; a majority of the improvement was the result of a 16 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 between the first half of 2014 and the first half of 2013. The average rate paid on repurchase agreements was 5 basis points less. Conversely, there were increases to the average rate on subordinated debentures and notes payable. The average rate paid on subordinated debentures and notes payable increased by 44 basis points due to the difference in the rate on notes payable between the two six month periods.

 

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COMMUNITY SHORES BANK CORPORATION

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

 

The quarter-to-quarter comparison of consolidated average interest earning assets and interest bearing liabilities and average yield on assets and average cost of liabilities for the second quarter ended June 30, 2014 and 2013 is in the table below.

 

   Three Months ended June 30, 
   2014   2013 
   Average       Average   Average       Average 
   Balance   Interest   Rate   Balance   Interest   Rate 
Assets                              
Federal funds sold and interest- bearing deposits with banks  $20,810,449   $12,742    0.24%  $13,462,955   $7,984    0.24%
Securities   30,401,472    108,815    1.43    37,581,116    137,710    1.47 
Loans (including held for sale and non accrual)   133,840,733    1,721,753    5.15    130,752,458    1,714,892    5.25 
Total interest earning assets   185,052,654    1,843,310    3.98    181,796,529    1,860,586    4.09 
Other assets   13,067,009              13,167,479           
   $198,119,663             $194,964,008           
Liabilities and Shareholders’ Equity                              
Interest-bearing deposits  $143,997,385   $210,977    0.59%  $140,808,852   $252,138    0.72%
Repurchase agreements   9,123,899    12,281    0.54    9,970,945    14,512    0.58 
Subordinated debentures and notes payable   5,780,000    55,332    3.83    5,780,000    55,321    3.83 
Total interest bearing liabilities   158,901,284    278,590    0.70    156,559,797    321,971    0.82 
Non-interest-bearing deposits   34,345,083              33,573,462           
Other liabilities   915,001              955,554           
Shareholders’ Equity   3,979,399              3,875,195           
   $198,140,767             $194,964,008           
Net interest income        1,564,720              1,538,615      
Net interest spread on earning assets             3.28%             3.27%
Net interest margin on earning assets             3.38%             3.39%
Average interest-earning assets to average interest-bearing liabilities             116.46%             116.12%

 

Net interest income increased $26,000 in the second quarter of 2014 over the similar period in 2013. Accordingly, the net interest spread on average earning assets improved by 1 basis point and was 3.28% compared to a spread of 3.27% for the second quarter of 2013. Conversely, the net interest margin for the second quarter of 2014 decreased 1 basis point against the comparable period in 2013. The net interest margin for the second quarter of 2014 was 3.38% compared to 3.39% for the second quarter of 2013. Although there was an 11 basis point decline in the yield on earning assets between the second quarter of 2014 and the same quarter in 2013, there was also a reduction in yield paid on interest-bearing liabilities of 12 basis points between the same two periods.

 

The average rate earned on interest earning assets was 3.98% for the three month period ending June 30, 2014, compared to 4.09% for the same period in 2013. The two biggest earning asset categories, securities and loans, each had a decline in yield when comparing the second quarter of 2014 to the similar period of 2013. The 10 basis point reduction to the average rate earned on the loan portfolio was the largest factor in the overall decrease.

 

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COMMUNITY SHORES BANK CORPORATION

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

 

Similar to the decrease to the overall yield on interest earning assets, there was a 12 basis point decline in the Company’s cost of funds. The main contributing factor was a 13 basis point improvement in the rate paid on interest bearing deposits when comparing the second quarter of 2014 to that of the similar period in 2013; the entire improvement was linked to a 17 basis point reduction in the average rate paid on the time deposit portfolio between the two periods.

 

Management will continue to seek ways to improve the cost of funds but it is unlikely that decreases will be enough to offset potential reductions in the average rate earned on earning assets. As such, management expects that the net interest margin may continue to decrease throughout the remaining quarters of 2014.

 

In general, the rate environment remains at historically low levels and management is continually challenged to improve its mix of assets and its net interest income, thus asset liability management remains an important tool for assessing interest rate sensitivity; it also provides a tool for monitoring liquidity. Liquidity management involves the ability to meet the cash flow requirements of the Company’s customers. These customers may be either borrowers with credit needs or depositors wanting to withdraw funds. Management of interest rate sensitivity attempts to avoid widely varying net interest margins and achieve consistent net interest income through periods of changing interest rates.

 

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

 

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COMMUNITY SHORES BANK CORPORATION

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

 

Details of the repricing gap at June 30, 2014 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  $18,381,632   $0   $0   $0   $18,381,632 
Securities (including FHLB stock)   2,710,989    4,503,277    20,911,520    3,573,615    31,699,401 
Loans held for sale                  111,200    111,200 
Loans   49,957,079    16,566,053    47,464,501    18,715,606    132,703,239 
    71,049,700    21,069,330    68,376,021    22,400,421    182,895,472 
Interest-bearing liabilities                         
Savings and checking   63,287,767    0    0    0    63,287,767 
Time deposits <$100,000   11,303,724    22,063,724    37,080,976    0    70,448,424 
Time deposits >$100,000   2,271,203    4,676,000    3,053,187    0    10,000,390 
Repurchase agreements and Federal funds purchased   10,020,151    0    0    0    10,020,151 
Notes payable and other borrowings   4,500,000    1,280,000    0    0    5,780,000 
    91,382,845    28,019,724    40,134,163    0    159,536,732 
Net asset (liability) repricing gap  $(20,333,145)  $(6,950,394)  $28,241,858   $22,400,421   $23,358,740 
Cumulative net asset (liability) repricing gap  $(20,333,145)  $(27,283,539)  $958,319   $23,358,740      

 

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 Open Market Committee of the Federal Reserve System has forecasted, a negative repricing gap should be helpful for further reduction to the Company’s overall interest expense, however it is unknown whether the reduction will offset the repricing opportunities for loans scheduled to renew. Nonetheless, 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.

 

There was no provision for loan losses for the first two quarters of 2013 or the first two quarters of 2014. 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.

 

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COMMUNITY SHORES BANK CORPORATION

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

 

Non-interest income recorded in the first six months of 2014 was $856,000 compared to $6.1 million recorded for the similar period in 2013. The difference stemmed mainly from a $5.3 million gain on the debt extinguishment. 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 including three directors of the Company; Gary F. Bogner, Robert L. Chandonnet, and Bruce J. Essex. On the same day, $500,000 of the proceeds were used to settle, in full, a defaulted debt with a financial institution. At closing, the balance owed was approximately $5.8 million. The extinguishment of debt resulted in a gain of $5.3 million.

 

Other differences in non-interest income stemmed from gains on the sale of foreclosed assets and residential real estate loans. In the first six months of 2014, foreclosed asset sales netted the Company $91,000 in gains while the foreclosed asset sales for the same period in 2013 resulted in net gains of $44,000. The $47,000 in additional gains on foreclosed asset sales helped to absorb lower than expected gains on the sale of residential real estate loans for the first half of 2014. During the first two quarters of 2014, gains on residential real estate sales were $65,000 and were $62,000 less than the same period in 2013. Although the rate environment continues to be very conducive to mortgage lending activity, the harsh weather in the first quarter and first few months of the second quarter of 2014 is believed to have negatively affected home sales.

 

Non-interest income for the second quarter of 2014 was $447,000 compared to $427,000 of non-interest income in the second quarter of 2013. Gains on residential real estate loan sales were $38,000 for the second quarter of 2014. For the similar period in 2013, gains on residential loan sales were $60,000. This $22,000 differential was fully negated by increases in other non-interest income, specifically rental income. Rental income received in the second quarter of 2014 was $30,000 more than the second quarter of 2013. In the fourth quarter of 2013, the Bank leased unused space at its Harvey Street location.

 

Non-interest expenses for the first half of 2014 were $3.8 million; $62,000 less than the total for the first half of 2013. Increases to salary, benefits and data processing expenses were more than offset by decreases to foreclosed asset impairments, equipment depreciation and collection expenses.

 

Non-interest expenses rounded to $1.9 million for the second quarter of 2014, the same total as the second quarter of 2013. As a result of further improvement in property values, foreclosed assets impairment charges were $47,000 less in the second quarter 2014 compared to the same quarter in 2013. This benefit helped to offset a difference in FDIC insurance premiums between the two quarters. FDIC Insurance expense netted to $51,000 in the second quarter of 2013. The expense for the year ago quarter included a $58,000 accrual adjustment for reduced premiums as a result of an improvement in the Bank’s regulatory capital ratio beginning in the first quarter of 2013.

 

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 net operating loss carry forward remaining was over $7 million at year-end 2013.

 

There was no income tax expense recorded for either the first or second quarter of 2014, however, as a result of the large gain on the extinguishment of debt noted above, the Company recorded income tax expense from operations in the amount of $105,000 in 2013’s first quarter. This amount represented projected taxable earnings subject to alternative minimum taxation.

 

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COMMUNITY SHORES BANK CORPORATION

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

 

ITEM 3.               QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable for smaller reporting companies.

 

ITEM 4.               CONTROLS AND PROCEDURES

 

We are required to maintain disclosure controls and procedures designed to ensure that material information related to us, including our consolidated subsidiaries, is recorded, processed, summarized, and reported within the time periods specified in the SEC rules and forms. Management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and fraud. Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.

 

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 June 30, 2014. Based on the evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2014.

 

There have been no changes in the internal control over financial reporting during the quarter ended June 30, 2014, 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 June 30, 2014.

 

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. Commencing 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 (see Note 10 to the Company’s Consolidated Financial Statements for additional details). 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).
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
     
August 14, 2014   By:   /s/ Heather D. Brolick
       Date   Heather D. Brolick
    President and Chief Executive Officer
    (principal executive officer)

 

August 14, 2014   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).
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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