COMMUNITY SHORES BANK CORP - FORM 10-Q

Attached files

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EX-32.2 - EXHIBIT 32.2 - COMMUNITY SHORES BANK CORP	v446769_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - COMMUNITY SHORES BANK CORP	v446769_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - COMMUNITY SHORES BANK CORP	v446769_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - COMMUNITY SHORES BANK CORP	v446769_ex31-1.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, 2016

¨ 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 x No

At August 15, 2016, 4,101,664 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	46

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	61

	Item 4.	Controls and Procedures	61

PART II.	Other Information

	Item 1.	Legal Proceedings	61

	Item 1A.	Risk Factors	61

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	61

	Item 3.	Defaults upon Senior Securities	62

	Item 4.	Mine Safety Disclosures	62

	Item 5.	Other Information	62

	Item 6.	Exhibits	62

	Signatures		63

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

	June 30,			December 31,
	2016			2015
	(unaudited)			(audited)
ASSETS
Cash and due from financial institutions	$	2,351,109		$	2,791,553
Interest-bearing deposits in other financial institutions		14,041,580			15,108,399
Total cash and cash equivalents		16,392,689			17,899,952
Securities available for sale (at fair value)		21,354,373			25,209,733
Loans held for sale		99,000			0
Loans		127,087,290			122,741,728
Less: Allowance for loan losses		1,638,581			1,671,416
Net loans		125,448,709			121,070,312
Federal Home Loan Bank stock (at cost)		300,500			300,500
Premises and equipment, net		8,654,345			8,820,502
Accrued interest receivable		360,201			369,442
Foreclosed assets		1,805,375			2,211,327
Net deferred tax assets		4,020,892			4,260,165
Other assets		521,596			879,367
Total assets	$	178,957,680		$	181,021,300
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Non-interest-bearing	$	36,628,382		$	39,236,718
Interest-bearing		119,317,755			121,944,921
Total deposits		155,946,137			161,181,639
Repurchase agreements		3,997,075			4,921,023
Subordinated debentures		4,500,000			4,500,000
Notes payable		0			1,280,000
Derivative liability		0			426,667
Accrued expenses and other liabilities		430,351			1,149,544
Total liabilities		164,873,563			173,458,873
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; 4,101,664 issued and outstanding at June 30, 2016 and 1,468,800 issued and outstanding at December 31, 2015		19,625,967			13,296,691
Retained deficit		(5,650,884	)		(5,705,469	)
Accumulated other comprehensive income (loss)		109,034			(28,795	)
Total shareholders’ equity		14,084,117			7,562,427
Total liabilities and shareholders’ equity	$	178,957,680		$	181,021,300

See accompanying notes to consolidated financial statements.

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COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	Three Months		Three Months			Six Months		Six Months
	Ended		Ended			Ended		Ended
	June 30,		June 30,			June 30,		June 30,
	2016		2015			2016		2015
Interest and dividend income
Loans, including fees	$	1,575,056	$	1,603,651		$	3,095,809	$	3,260,330
Securities (including FHLB dividends)		74,625		97,104			159,332		207,023
Federal funds sold and other income		22,256		3,481			42,132		7,775
Total interest and dividend income		1,671,937		1,704,236			3,297,273		3,475,128
Interest expense
Deposits		157,311		162,710			318,849		336,092
Repurchase agreements and other short-term debt		3,900		6,159			8,299		14,707
Federal Home Loan Bank advances and notes payable		31,417		56,489			91,894		112,023
Derivative valuation adjustment		0		426,667			0		426,667
Total interest expense		192,628		652,025			419,042		889,489
Net Interest Income		1,479,309		1,052,211			2,878,231		2,585,639
Provision for loan losses		0		0			0		0
Net Interest Income After Provision for Loan Losses		1,479,309		1,052,211			2,878,231		2,585,639
Non-interest income
Service charges on deposit accounts		107,489		141,849			229,379		278,083
Gain on sale of loans		37,018		39,641			70,719		71,976
Gain on sale of foreclosed assets		112,132		58,164			147,013		108,504
Gain on sale of premises and equipment		0		750			0		750
Other		216,211		196,667			408,051		384,679
Total non-interest income		472,850		437,071			855,162		843,992
Non-interest expense
Salaries and employee benefits		982,170		981,347			1,993,034		1,991,828
Occupancy		146,893		145,209			302,629		310,896
Furniture and equipment		101,499		82,011			189,496		166,077
Advertising		2,400		4,254			6,203		12,291
Data processing		120,485		172,016			239,006		337,141
Professional services		123,188		85,455			221,777		181,271
Foreclosed asset impairment		85,414		63,505			85,414		63,505
FDIC insurance		60,473		101,595			127,586		203,050
Other		215,356		206,262			490,461		466,677
Total non-interest expense		1,837,878		1,841,654			3,655,606		3,732,736
Income (Loss) Before Federal Income Taxes		114,281		(352,372	)		77,787		(303,105	)
Federal income tax expense (benefit)		35,610		(119,808	)		23,202		(103,056	)
Net Income (Loss)	$	78,671	$	(232,564	)	$	54,585	$	(200,049	)
Basic average shares outstanding		4,101,664		1,468,800			2,843,097		1,468,800
Diluted average shares outstanding		4,101,664		1,468,800			2,843,097		1,468,800
Basic income (loss) earnings per share	$	0.02	$	(0.16	)	$	0.02	$	(0.14	)
Diluted income (loss) earnings per share	$	0.02	$	(0.16	)	$	0.02	$	(0.14	)

See accompanying notes to consolidated financial statements.

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COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

	Three Months			Three Months			Six Months			Six Months
	Ended			Ended			Ended			Ended
	June 30, 2016			June 30, 2015			June 30, 2016			June 30, 2015

Net income (loss)	$	78,671		$	(232,564	)	$	54,585		$	(200,049	)

Other comprehensive income (loss):
Unrealized holding gains (losses) on available for sale securities		47,655			(88,431	)		208,833			1,935
Less reclassification adjustments for unrealized gains later recognized in income		0			0			0			0
		47,655			(88,431	)		208,833			1,935
Tax effect		(16,203	)		30,066			(71,004	)		(659	)
Other comprehensive income (loss), net of tax		31,452			(58,365	)		137,829			1,276

Comprehensive income (loss)	$	110,123		$	(290,929	)	$	192,414		$	(198,773	)

See accompanying notes to consolidated financial statements.

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COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

								Accumulated
								Other			Total
			Common		Retained			Comprehensive			Shareholders’
	Shares		Stock		Deficit			Income (Loss)			Equity

Balance at January 1, 2015		1,468,800	$	13,296,691	$	(4,944,867	)	$	(270,887	)	$	8,080,937

Net loss						(200,049	)					(200,049	)
Other comprehensive income									1,276			1,276

Balance at June 30, 2015		1,468,800	$	13,296,691	$	(5,144,916	)	$	(269,611	)	$	7,882,164

Balance at January 1, 2016		1,468,800	$	13,296,691	$	(5,705,469	)	$	(28,795	)	$	7,562,427

Proceeds from rights offering, net of issuance costs		1,383,299		3,290,183								3,290,183
Proceeds from private placement		579,412		1,477,501								1,477,501
Note payable conversion, including derivative liability, net of taxes		670,153		1,561,592								1,561,592
Net income						54,585						54,585
Other comprehensive income									137,829			137,829

Balance at June 30, 2016		4,101,664	$	19,625,967	$	(5,650,884	)	$	109,034		$	14,084,117

See accompanying notes to consolidated financial statements.

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COMMUNITY SHORES BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Six Months Ended			Six Months Ended
	June 30, 2016			June 30, 2015
Cash flows from operating activities
Net income (loss)	$	54,585		$	(200,049	)
Adjustments to reconcile net income (loss) to net cash from (used by) operating activities:
Depreciation and amortization		184,893			183,579
Net amortization of securities		110,551			148,067
Net realized gain on sale of securities		0			0
Net realized gain on sale of loans		(70,719	)		(71,976	)
Net realized gain on sale of foreclosed assets		(147,013	)		(108,504	)
Net realized gain on sale of premises and equipment		0			(750	)
Foreclosed asset impairment		85,414			63,505
Originations of loans for sale		(2,820,750	)		(2,968,690	)
Proceeds from loan sales		2,792,469			3,110,166
Deferred federal income tax expense (benefit)		23,202			(99,573	)
Valuation adjustment on derivative		0			426,667
Net change in:
Accrued interest receivable and other assets		367,013			(68,708	)
Accrued interest payable and other liabilities		(719,193	)		209,029
Net cash from (used by) operating activities		(139,548	)		622,763
Cash flows from investing activities
Activity in available for sale securities:
Sales		0			0
Maturities, prepayments and calls		3,953,641			3,264,728
Purchases		0			0
Loan originations and payments, net		(4,467,416	)		2,216,908
Redemption of Federal Home Loan Bank stock		0			87,900
Proceeds from the disposal of equipment		0			750
Additions to premises and equipment, net		(18,736	)		(65,672	)
Proceeds from the sale of foreclosed assets		556,570			108,504
Net cash from investing activities		24,059			5,613,118
Cash flows from financing activities
Net change in deposits		(5,235,502	)		8,035,342
Repayment of note payable		(8	)		0
Net change in repurchase agreements		(923,948	)		(3,650,994	)
Proceeds from rights offering, net of issuance cost		4,767,684			0
Proceeds from private placement		0			0
Net cash from (used by) financing activities		(1,391,774	)		4,384,348
Net change in cash and cash equivalents		(1,507,263	)		10,620,229
Beginning cash and cash equivalents		17,899,952			7,935,522
Ending cash and cash equivalents	$	16,392,689		$	18,555,751
Supplemental cash flows information:
Cash paid during the period for interest	$	1,080,845		$	405,403
Cash paid during the period for federal income tax		0			0
Non-cash financing activities:
Transfers from loans to foreclosed assets		89,019			70,891
Note payable conversion to common stock, including derivative and net of taxes		1,561,592			0

See accompanying notes to consolidated financial statements.

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COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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, 2016 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, 2016 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, 2015. 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, 1-4 family and 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.

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COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 reassessed 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 2016.

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 4. In recent periods, with charge-off activity lessening, the calculated historical loss factor assigned to general allocations was considerably reduced.

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COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 experienced directly impacts the general allocations to the consumer classes. Similar to the commercial segment, charge-off activity in the consumer segment has been lessening, thus reducing the calculated historical loss factor assigned to the general allocations.

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. Similar to the commercial, charge-off activity in the residential segment has been lessening, thus reducing the calculated historical loss factor assigned to the general allocations.

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 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.

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COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

There was no material change in these operating doctrines during the six months ended June 30, 2016.

ADOPTION OF NEW ACCOUNTING STANDARDS:

In June 2015, FASB issued ASU 2015-10, Technical Corrections and Improvements. This ASU contains amendments that will clarify and affect a variety of Topics in the FASB Accounting Standards Codification. The amendments in this Update that require transition guidance are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. All other amendments will be effective upon the issuance of this guidance. The adoption of this guidance did not have a material effect on the Company’s financial position or results of operations.

In November 2015, FASB issued ASU 2015-17, Income Taxes; Balance Sheet Classification of Deferred Taxes. This amendment of this update are intended to simplify the presentation of deferred income taxes and required that deferred tax assets and liabilities be classified as non-current in a classified statement of financial position. The amendments are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. The adoption of this guidance did not have a material effect on the Company’s financial position or results of operations.

In March 2016, FASB issued ASU 2016-09, Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting. This ASU is part of the Simplification Initiative to and involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity of liabilities, and classification on the statement of cash flows. The amendments in this Update are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. The adoption of this guidance did not have a material effect on the Company’s financial position or results of operations.

NEWLY ISSUED NOT YET EFFECTIVE ACCOUNTING STANDARDS:

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers. This ASU establishes a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The guidance in this ASU is effective for annual and interim periods beginning after December 15, 2016, with three transition methods available – full retrospective, retrospective and cumulative effect approach. At the July 9, 2015 FASB meeting, the FASB voted to delay the effective date by one year. The Company is in process of evaluating this new ASU to determine the potential impact on the Company’s financial position and/or results of operations.

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COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

In January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities”. The amendments in ASU 2016-01 address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. One such amendment requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option. The presentation addresses financial statement users’ feedback that presenting the total change in fair value of a liability in net income reduced the decision usefulness of an entity’s net income when it had a deterioration in its credit worthiness. ASU 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The new guidance must be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption. The adoption of this guidance is not expected to have a material effect on the Company’s financial position or results of operations.

In February 2016, the FASB issued ASU 2016-02 "Leases." From the lessee's perspective, the new standard establishes a right-of-use ("ROU") model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessee. From the lessor's perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing. If the lessor doesn’t convey risks and rewards or control, an operating lease results. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The adoption of this guidance is not expected to have a material effect on the Company’s financial position or results of operations.

In June 2016, the FASB issued ASU 2016-13 "Financial Instruments-Credit Losses" which introduces the current expected credit losses methodology (CECL) for estimating allowances for credit losses. The new accounting standard allows a financial institution to leverage its current internal credit risk systems as a framework for estimating expected credit losses. For public business entities (PBE) that are U.S. SEC filers, the new standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is in process of evaluating this new ASU to determine the potential impact on the Company’s financial position and/or results of operations.

Other issued but not yet effective accounting standards were reviewed and management has concluded that none apply or will be material to the Company’s financial statements.

- 10 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

RECENT DEVELOPMENTS

In the first quarter of 2016, the Company successfully completed a Rights Offering which was begun in the fourth quarter of 2015 and a concurrent private placement (See Note 13). On March 28, 2016, after receiving FRB approval to repay the interest due on the Company’s subordinated debentures and to increase the ownership percentages of certain investors in relation to the guidelines of the FRB Change in Bank Control Act, the Company received gross proceeds of approximately $5.0 million from two transactions. On the same date, the Company’s note payable with 1030 Norton LLC converted to 670,153 common shares, relieving the Company of any future interest payments. Two days later, on March 30, 2016, the Company repaid $722,000 of interest on its subordinated debentures and brought its obligations current. Finally, on March 31, 2016, the Company contributed $3.35 million of new capital into the Bank, enhancing its regulatory capital position.

- 11 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SECURITIES AVAILABLE FOR SALE

The following tables represent the securities held in the Company’s portfolio at June 30, 2016 and at December 31, 2015:

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
June 30, 2016	Cost		Gains		Losses			Value

US Treasury	$	1,504,504	$	7,762	$	0		$	1,512,266
US Government and federal agency		9,498,216		38,237		0			9,536,453
Municipals		0		0		0			0
Mortgage-backed and collateralized mortgage obligations– residential		10,186,449		121,325		(2,120	)		10,305,654
	$	21,189,169	$	167,324	$	(2,120	)	$	21,354,373

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
December 31, 2015	Cost		Gains		Losses			Value

US Treasury	$	1,505,941	$	5,387	$	0		$	1,511,328
US Government and federal agency		11,545,640		13,215		(14,235	)		11,544,620
Municipals		710,000		966		0			710,966
Mortgage-backed and collateralized mortgage obligations– residential		11,491,781		64,103		(113,065	)		11,442,819
	$	25,253,362	$	83,671	$	(127,300	)	$	25,209,733

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, 2016:

	Amortized		Fair
	Cost		Value
Due in one year or less	$	6,029,579	$	6,043,008
Due from one to five years		4,973,141		5,005,711
Due from five to ten years		0		0
Due in more than ten years		0		0
Mortgage-backed and collateralized mortgage obligations – residential		10,186,449		10,305,654
	$	21,189,169	$	21,354,373

- 12 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SECURITIES AVAILABLE FOR SALE (Continued)

Below is the table of securities with unrealized losses, aggregated by investment category and length of time such securities were in an unrealized loss position at June 30, 2016 and December 31, 2015:

	Less than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
June 30, 2016	Value		Losses			Value		Losses			Value		Losses
US Government and federal agency	$	0	$	0		$	0	$	0		$	0	$	0
Mortgage-backed and collateralized mortgage obligations - residential		234,888		(105	)		1,032,131		(2,015	)		1,267,019		(2,120	)
	$	234,888	$	(105	)	$	1,032,131	$	(2,015	)	$	1,267,019	$	(2,120	)

	Less than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
December 31, 2015	Value		Losses			Value		Losses			Value		Losses
US Government and federal agency	$	5,453,848	$	(14,235	)	$	0	$	0		$	5,453,848	$	(14,235	)
Mortgage-backed and collateralized mortgage obligations - residential		4,842,868		(38,336	)		3,268,525		(74,729	)		8,111,393		(113,065	)
	$	10,296,716	$	(52,571	)	$	3,268,525	$	(74,729	)	$	13,565,241	$	(127,300	)

No securities were sold in the three or six months ended June 30, 2016 or June 30, 2015.

- 13 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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, 2016 and December 31, 2015, 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, 2016, four debt securities had unrealized losses with aggregate depreciation of 0.17% from the amortized cost basis; three of the four had unrealized losses greater than 12 months.

Three of the four securities, which had an unrealized loss at June 30, 2016, are issued by government agencies and one is issued by a government-sponsored entity. It is likely that these debt securities will be retained given the fact that they are pledged to various public funds. The reported decline in value is not material and is deemed to be market driven. Because the decline in fair value is attributable to changes in interest rates and not credit quality and, because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery. The Company does not consider these securities to be other-than-temporarily impaired at June 30, 2016.

At June 30, 2016 and December 31, 2015, there were no holdings of securities of any one issuer, other than U.S. Government and federal agencies, in an amount greater than 10% of common stock and surplus.

- 14 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SECURITIES AVAILABLE FOR SALE (Continued)

Securities pledged at June 30, 2016 had a carrying amount of $14,512,073 and were pledged to secure public fund customers, customer repurchase agreements and, to a much lesser extent, potential borrowings at the FRB Discount Window. Pledged securities at December 31, 2015 had a carrying amount of $20,201,813.

LOANS

Outstanding loan balances by portfolio segment and class at June 30, 2016 and December 31, 2015 were as follows:

	June 30, 2016			December 31, 2015
Commercial	$	45,984,479		$	48,287,124
Commercial Real Estate:
General		51,303,714			48,327,074
Construction		4,955,502			2,189,127
Consumer:
Lines of credit		5,258,761			5,296,097
Other		1,167,148			1,167,709
Credit card		477,113			473,048
Residential		18,004,396			17,051,151
Net deferred loan fees		(63,823	)		(49,602	)
		127,087,290			122,741,728
Less: Allowance for loan losses		(1,638,581	)		(1,671,416	)
Loans, net	$	125,448,709		$	121,070,312

- 15 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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, 2016 and 2015 by portfolio segment:

Three Months Ended June 30, 2016	Commercial			Commercial Real Estate			Consumer			Residential			Unallocated			Total
Allowance for loan losses:
Beginning balance	$	556,274		$	453,238		$	314,571		$	215,109		$	165,852		$	1,705,044
Charge-offs		(69,664	)		(21,871	)		(33,748	)		0			0			(125,283	)
Recoveries		29,150			25,710			3,960			0			0			58,820
Provision for loan losses		66,651			3,525			(20,893	)		(3,195	)		(46,088	)		0
Ending balance	$	582,411		$	460,602		$	263,890		$	211,914		$	119,764		$	1,638,581

Three Months Ended June 30, 2015	Commercial		Commercial Real Estate			Consumer			Residential			Unallocated			Total
Allowance for loan losses:
Beginning balance	$	512,974	$	409,839		$	294,929		$	206,707		$	183,293		$	1,607,742
Charge-offs		0		(36,815	)		(13,610	)		0			0			(50,425	)
Recoveries		9,800		0			6,256			0			0			16,056
Provision for loan losses		7,077		53,604			(11,476	)		(9,918	)		(39,287	)		0
Ending balance	$	529,851	$	426,628		$	276,099		$	196,789		$	144,006		$	1,573,373

- 16 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued)

Six Months Ended June 30, 2016	Commercial			Commercial Real Estate			Consumer			Residential		Unallocated			Total
Allowance for loan losses:
Beginning balance	$	522,558		$	432,145		$	322,185		$	210,653	$	183,875		$	1,671,416
Charge-offs		(69,664	)		(21,871	)		(39,293	)		0		0			(130,828	)
Recoveries		39,553			25,710			32,730			0		0			97,993
Provision for loan losses		89,964			24,618			(51,732	)		1,261		(64,111	)		0
Ending balance	$	582,411		$	460,602		$	263,890		$	211,914	$	119,764		$	1,638,581

Six Months Ended June 30, 2015	Commercial		Commercial Real Estate			Consumer			Residential			Unallocated		Total
Allowance for loan losses:
Beginning balance	$	500,776	$	848,589		$	294,039		$	204,485		$	130,283	$	1,978,172
Charge-offs		0		(429,212	)		(14,087	)		0			0		(443,299	)
Recoveries		26,900		0			11,600			0			0		38,500
Provision for loan losses		2,175		7,251			(15,453	)		(7,696	)		13,723		0
Ending balance	$	529,851	$	426,628		$	276,099		$	196,789		$	144,006	$	1,573,373

- 17 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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, 2016 and December 31, 2015:

June 30, 2016	Commercial		Commercial Real Estate		Consumer		Residential		Unallocated		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	290,822	$	39,373	$	91,840	$	69,362	$	0	$	491,397
Collectively evaluated for impairment		291,589		421,229		172,050		142,552		0		1,027,420
Unallocated		0		0		0		0		119,764		119,764
Total ending allowance balance	$	582,411	$	460,602	$	263,890	$	211,914	$	119,764	$	1,638,581

Loans:
Individually evaluated for impairment	$	2,333,701	$	5,017,976	$	267,759	$	713,981	$	0	$	8,333,417
Collectively evaluated for impairment		43,727,546		51,322,229		6,659,160		17,337,784		0		119,046,719
Total ending loans balance	$	46,061,247	$	56,340,205	$	6,926,919	$	18,051,765	$	0	$	127,380,136

December 31, 2015	Commercial		Commercial Real Estate		Consumer		Residential		Unallocated		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	198,222	$	49,855	$	145,955	$	71,460	$	0	$	465,492
Collectively evaluated for impairment		324,336		382,290		176,230		139,193		0		1,022,049
Unallocated		0		0		0		0		183,875		183,875
Total ending allowance balance	$	522,558	$	432,145	$	322,185	$	210,653	$	183,875	$	1,671,416

Loans:
Individually evaluated for impairment	$	2,327,065	$	5,332,786	$	309,323	$	729,178	$	0	$	8,698,352
Collectively evaluated for impairment		46,048,707		45,261,236		6,650,819		16,368,778		0		114,329,540
Total ending loans balance	$	48,375,772	$	50,594,022	$	6,960,142	$	17,097,956	$	0	$	123,027,892

- 18 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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, 2016 and December 31, 2015. The recorded investment includes unpaid principal balance net of interest payments applied to principal (non-accrual loans only) as well as accrued interest receivable, deferred fees and costs. For purposes of this disclosure, the unpaid principal balance is not reduced for partial charge-offs.

	Recorded		Unpaid Principal		Related
June 30, 2016	Investment		Balance		Allowance
With no related allowance recorded:
Commercial	$	1,360,366	$	1,422,906	$	0
Commercial Real Estate:
General		4,959,784		6,050,866		0
Consumer:
Lines of credit		124,665		124,357		0
Other		0		0		0
Residential		401,803		434,333		0
Subtotal	$	6,846,618	$	8,032,462	$	0

With a related allowance recorded:
Commercial	$	973,335	$	986,782	$	290,822
Commercial Real Estate:
General		58,192		58,132		39,373
Consumer:
Lines of credit		121,528		120,902		70,279
Other		21,566		21,560		21,561
Residential		312,178		319,467		69,362
Subtotal	$	1,486,799	$	1,506,843	$	491,397
Total	$	8,333,417	$	9,539,305	$	491,397

- 19 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued)

	Recorded		Unpaid Principal		Related
December 31, 2015	Investment		Balance		Allowance
With no related allowance recorded:
Commercial	$	1,376,371	$	1,435,861	$	0
Commercial Real Estate:
General		5,220,711		6,381,061		0
Consumer:
Lines of credit		15,740		15,740		0
Other		0		0		0
Residential		414,528		446,950		0
Subtotal	$	7,027,350	$	8,279,612	$	0

With a related allowance recorded:
Commercial	$	950,694	$	957,412	$	198,222
Commercial Real Estate:
General		112,075		148,165		49,855
Consumer:
Lines of credit		277,230		276,275		129,617
Other		16,353		16,338		16,338
Residential		314,650		321,821		71,460
Subtotal	$	1,671,002	$	1,720,011	$	465,492
Total	$	8,698,352	$	9,999,623	$	465,492

- 20 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued)

The following tables present the average recorded investment of loans individually evaluated for impairment by class of loans as of June 30, 2016 and 2015 and the associated interest income. For purposes of this disclosure, the unpaid principal balance is not reduced for partial charge-offs.

	Three Months		Three Months		Three Months
	Average Recorded		Interest Income		Cash Basis
June 30, 2016	Investment		Recognized		Interest Recognized
With no related allowance recorded:
Commercial	$	1,364,290	$	11,865	$	11,730
Commercial Real Estate:
General		4,981,629		46,671		50,113
Consumer:
Lines of credit		109,978		2,232		2,259
Other		0		0		0
Residential		404,421		379		379
Subtotal	$	6,860,318	$	61,147	$	64,481

With a related allowance recorded:
Commercial	$	1,003,161	$	9,900	$	15,296
Commercial Real Estate:
General		56,756		363		363
Consumer:
Lines of credit		154,895		1,711		1,760
Other		14,010		353		424
Residential		313,648		3,210		4,269
Subtotal	$	1,542,470	$	15,537	$	22,112
Total	$	8,402,788	$	76,684	$	86,593

- 21 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued)

	Three Months		Three Months		Three Months
	Average Recorded		Interest Income		Cash Basis
June 30, 2015	Investment		Recognized		Interest Recognized
With no related allowance recorded:
Commercial	$	1,521,696	$	12,982	$	12,982
Commercial Real Estate:
General		5,715,583		51,062		41,157
Consumer:
Lines of credit		29,556		0		0
Other		0		0		0
Residential		245,504		456		456
Subtotal	$	7,512,339	$	64,500	$	54,595

With a related allowance recorded:
Commercial	$	433,346	$	5,655	$	5,655
Commercial Real Estate:
General		0		0		0
Consumer:
Lines of credit		296,122		4,145		4,125
Other		11,208		0		0
Residential		366,549		3,273		2,198
Subtotal	$	1,107,225	$	13,073	$	11,978
Total	$	8,619,564	$	77,573	$	66,573

- 22 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued)

	Six Months		Six Months		Six Months
	Average Recorded		Interest Income		Cash Basis
June 30, 2016	Investment		Recognized		Interest Recognized
With no related allowance recorded:
Commercial	$	1,365,016	$	23,796	$	23,661
Commercial Real Estate:
General		5,053,723		95,489		95,489
Consumer:
Lines of credit		92,006		3,947		3,903
Other		0		0		0
Residential		408,334		790		790
Subtotal	$	6,919,079	$	124,022	$	123,843

With a related allowance recorded:
Commercial	$	1,016,545	$	20,386	$	20,386
Commercial Real Estate:
General		84,415		363		363
Consumer:
Lines of credit		185,403		4,006		3,926
Other		14,217		674		643
Residential		314,413		6,445		6,445
Subtotal	$	1,614,993	$	31,874	$	31,763
Total	$	8,534,072	$	155,896	$	155,606

- 23 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued)

	Six Months		Six Months		Six Months
	Average Recorded		Interest Income		Cash Basis
June 30, 2015	Investment		Recognized		Interest Recognized
With no related allowance recorded:
Commercial	$	1,453,896	$	25,965	$	25,965
Commercial Real Estate:
General		5,444,790		102,045		84,649
Consumer:
Lines of credit		58,601		0		0
Other		0		0		0
Residential		202,277		921		921
Subtotal	$	7,159,564	$	128,931	$	111,535

With a related allowance recorded:
Commercial	$	427,605	$	11,284	$	10,581
Commercial Real Estate:
General		773,663		0		0
Consumer:
Lines of credit		286,358		8,679		8,572
Other		11,261		0		0
Residential		379,429		7,485		6,410
Subtotal	$	1,878,316	$	27,448	$	25,563
Total	$	9,037,880	$	156,379	$	137,098

- 24 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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, 2016:

					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	$	573,735	$	0	$	0	$	573,735	$	45,457,194	$	46,030,929
Commercial Real Estate:
General		103,678		177,893		0		281,571		50,365,888		50,647,459
Construction		0		0		0		0		4,956,506		4,956,506
Consumer:
Lines of credit		0		0		0		0		5,278,219		5,278,219
Other		5,299		0		0		5,299		1,166,288		1,171,587
Credit card		2,515		0		0		2,515		474,598		477,113
Residential		0		0		0		0		17,933,331		17,933,331
Total	$	685,227	$	177,893	$	0	$	863,120	$	125,632,024	$	126,495,144

					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	$	17,771	$	17,771	$	12,547	$	30,318
Commercial Real Estate:
General		0		0		0		0		736,240		736,240
Construction		0		0		0		0		0		0
Consumer:
Lines of credit		0		0		0		0		0		0
Other		0		0		0		0		0		0
Credit card		0		0		0		0		0		0
Residential		0		49,385		0		49,385		69,049		118,434
Total	$	0	$	49,385	$	17,771	$	67,156	$	817,836	$	884,992

- 25 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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, 2015:

					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	$	2,755	$	0	$	0	$	2,755	$	48,359,211	$	48,361,966
Commercial Real Estate:
General		184,598		93,311		0		277,909		47,122,559		47,400,468
Construction		0		0		0		0		2,193,139		2,193,139
Consumer:
Lines of credit		0		0		0		0		5,273,114		5,273,114
Other		0		0		0		0		1,166,822		1,166,822
Credit card		0		12,481		0		12,481		460,567		473,048
Residential		263,553		0		0		263,553		16,708,219		16,971,772
Total	$	450,906	$	105,792	$	0	$	556,698	$	121,283,631	$	121,840,329

					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	$	13,806	$	13,806
Commercial Real Estate:
General		0		0		113,290		113,290		887,125		1,000,415
Construction		0		0		0		0		0		0
Consumer:
Lines of credit		0		0		41,336		41,336		0		41,336
Other		0		0		5,822		5,822		0		5,822
Credit card		0		0		0		0		0		0
Residential		50,702		75,482		0		126,184		0		126,184
Total	$	50,702	$	75,482	$	160,448	$	286,632	$	900,931	$	1,187,563

- 26 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 $460,310 of specific reserves on $7,847,721 of unpaid principal balance of loans to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2016 and $401,072 on $7,965,816 of unpaid principal balance of loans as of December 31, 2015. At June 30, 2016, the Company had an additional $73,801 in performing loans outstanding to two of those customers. As of December 31, 2015, there was $75,776 committed to the same two customers.

The following tables present loans by class modified as troubled debt restructurings that occurred during the three and six month periods ended June 30, 2016:

			Pre-Modification		Post-Modification
			Outstanding Recorded		Outstanding Recorded
Three Months Ended June 30, 2016	Number of Loans		Investment		Investment
Troubled Debt Restructurings:
Commercial		1	$	15,107	$	15,107
Commercial Real Estate:
General		1		58,194		58,194
Consumer:
Other		1		11,566		11,566
Total		3	$	84,867	$	84,867

- 27 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued)

			Pre-Modification		Post-Modification
			Outstanding Recorded		Outstanding Recorded
Six Months Ended June 30, 2016	Number of Loans		Investment		Investment
Troubled Debt Restructurings:
Commercial		1	$	15,107	$	15,107
Commercial Real Estate:
General		1		58,194		58,194
Consumer:
Other		1		11,566		11,566
Total		3	$	84,867	$	84,867

For the three and six month periods ending June 30, 2016, one modification involved a stated interest rate below the current market rate for a period of 7 years. Two modifications involved a reduced payment amount for a period ranging from 4 months to 9 months.

For the six month period ended June 30, 2016, there were no charge-offs related to troubled debt restructurings. As of June 30, 2016, an additional $50,937 of specific reserves were established on these troubled debt restructurings.

The following tables present loans by class modified as troubled debt restructurings that occurred during the three and six month periods ended June 30, 2015:

			Pre-Modification		Post-Modification
			Outstanding Recorded		Outstanding Recorded
Three Months Ended June 30, 2015	Number of Loans		Investment		Investment
Troubled Debt Restructurings:
Residential		1	$	272,800	$	272,800
Total		1	$	272,800	$	272,800

			Pre-Modification		Post-Modification
			Outstanding Recorded		Outstanding Recorded
Six Months Ended June 30, 2015	Number of Loans		Investment		Investment
Troubled Debt Restructurings:
Residential		1	$	272,800	$	272,800
Total		1	$	272,800	$	272,800

For the three and six month periods ending June 30, 2015 the modification involved a financing concession on an amortizing note for a term of 19 years. There were no charge-offs related to this loan.

- 28 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued)

For the three and six month periods ending June 30, 2016 there was one troubled debt restructuring that experienced a payment default within 12 months following the modification. For the three and six month periods ending June 30, 2015 there were no troubled debt restructurings that experienced a payment default. Below is a table which presents that loan by class:

			Recorded Investment
	Number of Loans		at time of default
Troubled Debt Restructurings
That Subsequently Defaulted:
Commercial		1	$	18,301
Total		1	$	18,301

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. 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.

- 29 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued)

As of June 30, 2016 and December 31, 2015, 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,
	2016		2015		2016		2015		2016		2015
1	$	2,510,475	$	871,535	$	0	$	0	$	0	$	0
2		0		0		1,637,964		1,698,136		0		0
3		11,560,739		12,001,827		5,629,654		4,599,484		205,403		65,780
4		10,824,841		12,742,910		16,843,762		14,367,694		1,634,526		264,961
5		15,608,923		18,581,320		14,554,090		15,120,148		1,622,025		371,762
5M		2,907,166		1,426,772		2,696,100		3,940,477		0		0
6		692,689		798,475		9,091,699		7,472,404		1,494,552		1,490,636
7		1,943,765		1,939,064		193,671		333,169		0		0
8		12,649		13,869		736,759		869,371		0		0
Total	$	46,061,247	$	48,375,772	$	51,383,699	$	48,400,883	$	4,956,506	$	2,193,139

In the first quarter of 2016, there was a $1.4 million commercial real estate loan secured by Class A medical office space that was downgraded because of weak cashflow, delinquent property taxes and deficient collateral coverage. At December 31, 2015, this commercial real estate loan was in the 5M risk category and at March 31 and June 30, 2016 it was in risk category 6. Management has increased its oversight of this credit and will continue to work with the borrower to ensure that the current leases are renewed and well managed.

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, 2016 and December 31, 2015:

	Residential
	June 30,		December 31,
	2016		2015
Performing	$	17,337,784	$	16,368,778
Impaired		713,981		729,178
Total	$	18,051,765	$	17,097,956

	Consumer – Lines of credit				Consumer – Other				Consumer – Credit card
	June 30,		December 31,		June 30,		December 31,		June 30,		December 31,
	2016		2015		2016		2015		2016		2015
Performing	$	5,032,026	$	5,021,480	$	1,150,021	$	1,156,291	$	477,113	$	473,048
Impaired		246,193		292,970		21,566		16,353		0		0
Total	$	5,278,219	$	5,314,450	$	1,171,587	$	1,172,644	$	477,113	$	473,048

- 30 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FORECLOSED ASSETS

Foreclosed asset activity at June 30:

	June 30,			June 30,
	2016			2015
Beginning of year	$	2,211,327		$	2,238,997
Additions		89,019			64,388
Reductions from sales		(409,557	)		0
Direct write-downs		(85,414	)		(63,505	)
End of period	$	1,805,375		$	2,239,880

Expenses related to foreclosed assets include:
Operating expenses, net of rental income	$	45,164		$	76,614

A significant portion of the operating expenses is related to property taxes paid on the foreclosed assets. These amounts can vary from year-to-year depending on the number and types of foreclosed properties as well as the timing of the payments.

PREMISES AND EQUIPMENT

Period end premises and equipment were as follows at June 30, 2016 and December 31, 2015:

	June 30,		December 31,
	2016		2015
Land & land improvements	$	4,703,312	$	4,703,312
Buildings & building improvements		6,332,060		6,332,060
Furniture, fixtures and equipment		3,223,542		3,314,126
		14,258,914		14,349,498
Less: accumulated depreciation		5,604,569		5,528,996
	$	8,654,345	$	8,820,502

Depreciation expenses were $184,893 and $183,579 for the six months ended June 30, 2016 and 2015, respectively.

- 31 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DEPOSITS

The components of the outstanding deposit balances at June 30, 2016 and December 31, 2015 were as follows:

	June 30,		December 31,
	2016		2015
Non-interest-bearing DDA	$	36,628,382	$	39,236,718
Interest-bearing DDA		39,469,120		36,675,745
Money market		21,839,576		21,992,206
Savings		27,203,684		24,446,559
Time, under $100,000		21,841,508		29,272,313
Time, over $100,000		8,963,867		9,558,098
Total Deposits	$	155,946,137	$	161,181,639

Time deposits of $250,000 or more were $1,382,157 at June 30, 2016 and $1,377,420 at December 31, 2015. There were no brokered deposits at either June 30, 2016 or December 31, 2015.

SHORT-TERM BORROWINGS

The Company’s short-term borrowings outstanding consisted entirely of repurchase agreements at June 30, 2016 and December 31, 2015. The Company utilized its line of credit with the FHLB for overnight liquidity support only during 2015. Information regarding repurchase agreements and borrowings from the FHLB is summarized below:

	Repurchase			Borrowings
	Agreements			from FHLB

Outstanding at June 30, 2016	$	3,997,075		$	0
Average interest rate at period end		0.39	%		0	%
Average balance during period		4,021,460			0
Average interest rate during period		0.41	%		0	%
Maximum month end balance during period		4,829,527			0

Outstanding at December 31, 2015	$	4,921,023		$	0
Average interest rate at year-end		0.42	%		0	%
Average balance during year		5,411,588			135,068
Average interest rate during year		0.44	%		0.37	%
Maximum month end balance during year		8,829,269			0

The Bank had securities of $4,088,657 pledged to repurchase agreements at June 30, 2016 and $5,341,286 pledged at December 31, 2015. The Company had approximately $2.5 million of residential mortgage loans pledged to support its line of credit with the FHLB at June 30, 2016.

- 32 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SHORT-TERM BORROWINGS (Continued)

The potential risk associated with the Repurchase Agreements and related pledge collateral, including obligations arising from a decline in fair value of the pledged collateral, are minimal due to the fact that the Repurchase Agreements pertain to overnight borrowings and therefore not subject to fluctuations in fair market value. The following table represents the type of securities pledged to the Repurchase Agreements:

Securities Pledged to Repurchase Agreements	June 30, 2016		December 31, 2015
U.S. Treasury and agency securities	$	0	$	458,700
Asset-backed securities		3,310,549		4,002,129
Other		778,108		880,457
Total	$	4,088,657	$	5,341,286

Another source of short-term borrowings is available through the Federal Reserve Discount Window (“Discount Window”). At June 30, 2016, collateral pledged for Discount Window borrowings consisted of $335,225 in home equity loans while at December 31, 2015 the collateral pledged consisted of $332,768 in home equity loans, one security valued at $661,271 and one USDA loan valued at $3,408,161. The borrowing capacity decreased in the first quarter of 2016 due to the USDA loan no longer fulfilling the pledge requirements of the FRB and the security that was pledged was called. Also occurring in the first quarter of 2016, the Bank was upgraded from the secondary to the primary credit program. The primary credit program awards more value for pledged collateral and also borrowings are fully directed by the Bank and do not require regulator approval.

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 $2,450,656 at June 30, 2016. Each borrowing requires a direct pledge of securities and/or loans. To support potential borrowings with the FHLB, the Bank had loans with a carrying value of $5,667,188 pledged at June 30, 2016 and $7,511,449 pledged at year-end 2015. The Bank uses a portion of the loans pledged to the FHLB as collateral for a $2,000,000 overdraft line of credit. The remaining pledged loans are available to collateralize longer term FHLB borrowings. The Bank had no balance outstanding on the line of credit or other borrowings with the FHLB at either June 30, 2016 or December 31, 2015.

10.

SUBORDINATED DEBENTURES

The Trust, as discussed 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 2.68% at June 30, 2016 and 2.65% at December 31, 2015. 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 30^th, June 30^th, September 30^th and December 30^th. 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.

- 33 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10.

SUBORDINATED DEBENTURES (Continued)

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 exercised its option to defer each regularly scheduled interest payment from June 2010 through March 2015. The Company’s deferral of interest during that period did not constitute an event of default.

The last allowable deferral period was March 30, 2015. All accrued and unpaid interest was due and payable and a corresponding amount of distributions was payable on the trust preferred securities on June 30, 2015. The Company did not have the liquidity to pay the interest owed at that time. On March 30, 2016, the Company remitted an interest payment of approximately $722,000 (which consisted of $673,000 of accrued interest and $49,000 of interest on the deferred interest) curing the interest payment default utilizing proceeds from its Rights Offering and concurrent private placement discussed in Note 13.

On April 27, 2016, the Company’s Board of Directors voted to again defer interest payments in order to preserve its cash for general operations and potential capital support for the Bank as it grows. The deferral of interest does not constitute an event of default. 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, 2016, and the accrued interest payable on the subordinated debentures at that time was $32,108.

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. The proceeds of the senior debt were used to settle a defaulted note with another financial institution, to fund general operations and to make interest payments until the repayment or maturity of the note. The note bore interest at a fixed rate of 8.00% per annum until paid in full. While the note was outstanding, interest was paid quarterly, in arrears. The note was 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 note maturity was extended for another two year period in the first quarter of 2015. As a result, the note’s maturity became March 31, 2017.

The Company’s note payable with 1030 Norton LLC included a beneficial conversion feature allowing repayment of the outstanding principal with common stock instead of cash at a discount of 25% below the general offering price should an offering of stock be carried out by the Company. On October 2, 2015, the Company entered into a Debt Conversion Agreement with 1030 Norton LLC. The Debt Conversion Agreement provided that 1030 Norton LLC would convert the principal balance of its note into shares of common stock of the Company at a conversion price of $1.91 per share, which equaled 75% of the per share purchase price established by the Board of Directors of the Company in connection with its Rights Offering.

- 34 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11.

NOTES PAYABLE (Continued)

The note payable conversion to equity was completed on March 28, 2016 simultaneously with the closing of the Rights Offering. The balance of the note payable was settled in exchange for 670,153 shares of stock issued to the members of 1030 Norton LLC and a check for $7.77 due to fractional shares. Upon consummation of the conversion, the Company made a final interest payment of $24,747 and 1030 Norton LLC released the Company’s pledge of 100% of the shares of Community Shores Bank.

12.

DERIVATIVE LIABILITY

The beneficial conversion feature embedded in the Company’s note payable to 1030 Norton LLC was recorded as a liability through interest expense for the Company during 2015. At June 30, 2015, the conditions for the conversion were met and the liability was recorded. The value of the liability was established at $426,667, which represented a 25% per share discount on the stock to be issued in exchange for the outstanding note payable from the price per share of the Company’s stock established in the Rights Offering.

Similar to the related note payable discussed in Note 11, the derivative liability, net of related deferred tax, was reclassified to shareholder’s equity at conversion on March 28, 2016.

13.

SHAREHOLDER’S EQUITY

Sale of Common Stock

The Company initiated a Rights Offering in October 2015 with the intention of increasing the Company’s liquidity, repaying deferred and overdue interest on its subordinated debentures and contributing capital to the Bank.

The Rights Offering consisted of a distribution of nontransferable subscription rights to its shareholders of record as of October 12, 2015. Each shareholder of record received 1.7488 rights for each share of the Company’s common stock they owned as of the record date. Each right enabled its holder to purchase one share of the Company’s common stock at a price of $2.55 per share. Additionally, rights holders were given an oversubscription privilege to subscribe for a portion of the Rights Offering shares that were not purchased by other rights holders. The shares of the Company’s Common Stock sold in the Rights Offering totaled 1,383,299. The Rights Offering was closed on March 28, 2016 and garnered proceeds of approximately $3,300,000 (gross proceeds of $3,527,000 and offering costs of $237,000).

Concurrent with the closing of the Rights Offering, the Company finalized the sale of 579,412 shares of Common Stock through a private placement, also at $2.55 per share. Total proceeds received from this transaction were approximately $1,500,000. There was no issuance cost associated with the private placements.

- 35 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

14.

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, 2016 and December 31, 2015 follows:

	June 30, 2016		December 31, 2015

Unused lines of credit	$	29,465,720	$	24,532,524
Unused standby letters of credit		1,450,000		1,362,000
Commitments to make loans		727,195		357,900

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.

15.

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’s 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.

- 36 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15.

FAIR VALUE MEASUREMENTS (Continued)

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 Assets: 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.

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.

- 37 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15.

FAIR VALUE MEASUREMENTS (Continued)

Assets measured at fair value on a recurring basis are summarized below as of June 30, 2016 and December 31, 2015:

			Fair Value Measurements Using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
June 30, 2016	Total		(Level 1)		(Level 2)		(Level 3)
Available for sale securities:
US Treasury	$	1,512,266	$	1,512,266	$	0	$	0
US Government and federal agency		9,536,453		0		9,536,453		0
Municipals		0		0		0		0
Mortgage-backed and collateralized mortgage obligations– residential		10,305,654		0		10,305,654		0
Total	$	21,354,373	$	1,512,266	$	19,842,107	$	0

Servicing assets	$	1,895	$	0	$	1,895	$	0

			Fair Value Measurements Using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
December 31, 2015	Total		(Level 1)		(Level 2)		(Level 3)
Available for sale securities:
US Treasury	$	1,511,328	$	1,511,328	$	0	$	0
US Government and federal agency		11,544,620		0		11,544,620		0
Municipals		710,966		0		710,966		0
Mortgage-backed and collateralized mortgage obligations– residential		11,442,819		0		11,442,819		0
Total	$	25,209,733	$	1,511,328	$	23,698,405	$	0

Servicing assets	$	5,151	$	0	$	5,151	$	0

There were no transfers between levels during the first half of 2016 or 2015.

- 38 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15.

FAIR VALUE MEASUREMENTS (Continued)

Assets measured at fair value on a non-recurring basis are summarized below for the periods ended June 30, 2016 and December 31, 2015:

			Quoted Prices in		Significant
			Active Markets for		Other Observable		Significant
			Identical Assets		Inputs		Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
June 30, 2016
Impaired loans¹:	$	1,550,343	$	0	$	0	$	1,550,343
Foreclosed assets:		1,805,375		0		0		1,805,375
Total	$	3,355,718	$	0	$	0	$	3,355,718

			Quoted Prices in		Significant
			Active Markets for		Other Observable		Significant
			Identical Assets		Inputs		Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
December 31, 2015
Impaired loans¹:	$	1,728,358	$	0	$	0	$	1,728,358
Foreclosed assets:		2,211,327		0		0		2,211,327
Total	$	3,939,685	$	0	$	0	$	3,939,685

¹ Collateral dependent

- 39 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15.

FAIR VALUE MEASUREMENTS (Continued)

The following tables present information as of June 30, 2016 and December 31, 2015 about significant unobservable inputs related to the Bank’s individually material Level 3 financial assets, by class, measured on a non-recurring basis:

	Valuation	Significant Unobservable	Range
June 30, 2016	Technique	Inputs	of Inputs
Impaired loans	Sales comparison approach	Adjustments for differences between comparable sales		(25)-19	%
	Income approach	Capitalization rate		9.5-12.5	%

Foreclosed assets	Sales comparison approach	Adjustments for differences between comparable sales		(17)-14	%

	Valuation	Significant Unobservable	Range
December 31, 2015	Technique	Inputs	of Inputs
Impaired loans	Sales comparison approach	Adjustments for differences between comparable sales		(25)-19	%
	Income approach	Capitalization rate		9.5-12.5	%

Foreclosed assets	Sales comparison approach	Adjustments for differences between comparable sales		(25)-10	%

- 40 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15.

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, 2016 Using
	Carrying
	Amount		Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Cash and cash equivalents	$	16,393	$	16,393	$	0	$	0	$	16,393
Loans held for sale		99		0		102		0		102
Loans, net (including impaired)		125,449		0		0		123,422		123,422
FHLB stock		301		N/A		N/A		N/A		N/A
Accrued interest receivable		360		5		62		293		360

Financial liabilities
Deposits		155,946		0		154,350		0		154,350
Repurchase agreements		3,997		0		3,997		0		3,997
Subordinated debentures		4,500		0		0		3,292		3,292
Notes payable		0		0		0		0		0
Accrued interest payable		52		0		20		8		28

			Fair Value Measurements
			at December 31, 2015 Using
	Carrying
	Amount		Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Cash and cash equivalents	$	17,900	$	17,900	$	0	$	0	$	17,900
Loans held for sale		0		0		0		0		0
Loans, net (including impaired)		121,070		0		0		118,273		118,273
FHLB stock		301		N/A		N/A		N/A		N/A
Accrued interest receivable		369		5		78		286		369

Financial liabilities
Deposits		161,182		0		153,487		0		153,487
Repurchase agreements		4,921		0		4,921		0		4,921
Subordinated debentures		4,500		0		0		3,172		3,172
Notes payable		1,280		0		0		1,707		1,707
Accrued interest payable		734		0		20		198		218

- 41 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15.

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 2 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) Repurchase agreements and other short-term borrowings

The carrying amounts of 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.

- 42 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15.

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.

16.

INCOME TAXES

The realization of deferred tax assets is largely dependent upon future taxable income, future reversals of existing taxable temporary differences, and the ability to carryback losses to available tax years. In assessing the need for a valuation allowance, all available positive and negative evidence is considered, including taxable income in carry-back years, scheduled reversals of deferred tax liabilities, expected future taxable income and tax planning strategies.

Although the Company’s income is marginal, the outlook for future earnings is positive. Considering the reduction in debt expense and significant operational expenses such as data processing and various insurances as well as a strong loan pipeline and capital to support growth, management concluded that no valuation allowance on the Company’s net deferred tax asset was necessary at June 30, 2016. Net operating losses will begin expiring in 2030 through 2035.

There were no unrecognized tax benefits at June 30, 2016 or December 31, 2015, and the Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next 12 months. The Company is subject to examination by the Internal Revenue Service for years after 2011.

17.

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.

The five prompt corrective action classifications are well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. For instance, if a bank is not well capitalized, regulatory approval is required to accept brokered deposits. And generally, 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.

- 43 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

17.

REGULATORY MATTERS (Continued)

Under final Basel III capital rules that became effective on January 1, 2015, there was a requirement for a capital conservation buffer of 2.5% of risk-weighted assets to be phased in over four years at an incremental rate of 0.625% each year beginning in 2016. When fully phased in, this would result in a minimum CET1 ratio of 7%, a minimum total capital to risk-weighted asset ratio of 10.5%, and a minimum Tier 1 capital to risk-weighted asset ratio of 8.5%. Banks that do not maintain this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases, and on the payment of discretionary bonuses to senior executive management. As of June 30, 2016, the capital conservation buffer was 3.57%.

On March 31, 2016, following a $3.35 million contribution of capital from the Company, the Bank’s capital ratios were elevated to a level of well-capitalized according to prompt corrective action regulations. On that date, the Bank’s total risk-based capital ratio was 11.90% and its Tier 1 to average assets ratio was 8.06%; both above the minimum required to be well-capitalized.

The Bank was considered adequately capitalized at year-end 2015. At December 31, 2015, the Bank’s total risk-based capital ratio was 9.46% and its Tier 1 to average assets ratio was 6.12%; both well above the minimum required for capital adequacy.

Actual capital amounts and ratios for the Bank and, required capital amounts and ratios for the Bank to be well capitalized at June 30, 2016 and December 31, 2015 were:

											Minimum Required
											to Be Well
						Minimum Required					Capitalized Under
						For Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
June 30, 2016
Common Equity Tier 1 (CET1) to risk-weighted assets of the Bank	$	14,547,049		10.40	%	$	6,296,902		4.50	%	$	9,095,525		6.50	%
Total Capital (Tier 1 and Tier 2) to risk-weighted assets of the Bank		16,185,630		11.57			11,194,493		8.00			13,993,116		10.00
Tier 1 (Core) Capital to risk-weighted assets of the Bank		14,547,049		10.40			8,395,869		6.00			11,194,493		8.00
Tier 1 (Core) Capital to average assets of the Bank		14,547,049		8.12			7,169,776		4.00			8,962,220		5.00

- 44 -

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

17.

REGULATORY MATTERS (Continued)

											Minimum Required
											to Be Well
						Minimum Required					Capitalized Under
						For Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
December 31, 2015
Common Equity Tier 1 (CET1) to risk-weighted assets of the Bank	$	11,112,069		8.22	%	$	6,082,087		4.50	%	$	8,785,237		6.50	%
Total Capital (Tier 1 and Tier 2) to risk-weighted assets of the Bank		12,783,486		9.46			10,812,599		8.00			13,515,749		10.00
Tier 1 (Core) Capital to risk-weighted assets of the Bank		11,112,069		8.22			8,109,449		6.00			10,812,599		8.00
Tier 1 (Core) Capital to average assets of the Bank		11,112,069		6.12			7,257,858		4.00			9,072,322		5.00

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 both June 30, 2016 and December 31, 2015, the entire allowance for loan loss was counted as Tier 2 capital; nothing was disallowed. The allowance for loan losses was $1,638,581 at June 30, 2016 and $1,671,416 at December 31, 2015.

- 45 -

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, 2016 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, 2016 to that at December 31, 2015. The part labeled Results of Operations discusses the three and six month periods ending June 30, 2016 as compared to the same periods of 2015. Both parts should be read in conjunction with the interim consolidated financial statements and footnotes included in Item 1 of Part I of this Form 10-Q.

This discussion and analysis of financial condition and results of operations, and other sections of the Form 10-Q contain forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about the Company, the Bank, the Mortgage Company, Berryfield and CS Financial Services. Words such as “anticipates”, “believes”, “estimates”, “expects”, “forecasts”, “intends”, “is likely”, “plans”, “projects”, variations of such words and similar expressions are intended to identify such forward-looking statements. These forward-looking statements are intended to be covered by the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“Future Factors”) that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. The Company undertakes no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events (whether anticipated or unanticipated), or otherwise.

Future factors include, among others, changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulation or actions by bank regulators; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; changes in the national and local economy; the Company’s ability to generate future taxable income; 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 Written Agreement may result in further regulatory action that could have a material adverse effect on the Company and its 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.

In the first quarter of 2016, the Company successfully completed a Rights Offering which was begun in the fourth quarter of 2015 and a concurrent private placement (See Note 13). On March 28, 2016, after receiving FRB approval to repay the interest due on the Company’s subordinated debentures and to increase the ownership percentages of certain investors in relation to the guidelines of the FRB Change in Bank Control Act, the Company received gross proceeds of approximately $5.0 million from these two transactions. On the same date, the Company’s note payable with 1030 Norton LLC converted to 670,153 common shares, relieving the Company of any future interest payments. Two days later, on March 30, 2016, the Company repaid $722,000 of interest on its subordinated debentures and brought its obligations current. Finally, on March 31, 2016, the Company contributed $3.35 million of new capital into the Bank, enhancing its regulatory capital position.

- 46 -

COMMUNITY SHORES BANK CORPORATION

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

The recent capital raise allowed the Company to improve its financial condition and to strengthen the capital position of the Bank. However, the Written Agreement between the Company and the FRB, which became effective on December 16, 2010, remains in effect. 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.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES:

There have been no material changes to the application of critical accounting estimates and policies that were discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. For a complete summary of our significant accounting policies, see the notes to the consolidated financial statements and our Annual Report on 10-K for the fiscal year ended December 31, 2015.

FINANCIAL CONDITION

Total assets were $179.0 million at June 30, 2016 compared to $181.0 million at December 31, 2015. Total assets decreased by $2.0 million in the first six months of the year. Proceeds from the Rights Offering and excess liquidity were used to fund deposit decreases consisting primarily of non-local time deposits.

Cash and cash equivalents decreased by $1.5 million to $16.4 million at June 30, 2016 from $17.9 million at December 31, 2015. Essentially the entire decrease was due to a decline in the Bank’s FRB balance which was $15.1 million at year-end 2015 and was $14.0 million on June 30, 2016. The decrease in balance was driven largely by maturing time deposits. The Bank’s average balance at the FRB for the first six months of year was $16.7 million; higher than what is optimal for normal operations. 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. Although excess liquidity is a conservative posture, it is detrimental to earnings. The FRB balance is expected to be reduced in the second half of the year due to the deposit activities of the Bank’s public fund customers as well as upcoming loan originations.

- 47 -

COMMUNITY SHORES BANK CORPORATION

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

The Bank’s security portfolio was $21.4 million at June 30, 2016 and $25.2 million at December 31, 2015. Investment activity in the first six months of the year consisted of maturities, prepayments and calls totaling $4.0 million offset by an increase in fair value of $209,000.

Although the investment portfolio is declining, the Bank seeks to diligently manage unencumbered securities to ensure there are enough available to meet parameters required by several of the Bank’s operating policies. Unencumbered securities are those that are not pledged to any other entity. As such, they serve as a key source of collateral or potential liquidity for the Bank. The level of unpledged securities is formally assessed monthly. Maintaining an adequate level of pledgeable assets 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, 2016, 32% of the investment portfolio was unencumbered. This outcome is much higher than required and also higher than the 20% unpledged position that existed on December 31, 2015. The increase in unencumbered investments was due to the release of approximately $4 million of pledged investments. The Bank had originally pledged the investments to two of its public fund deposit customers when the Bank was under a regulatory Consent Order. The securities were released in the second quarter of 2016 after the public fund customers were notified of the Consent Order’s termination. The Bank will likely reduce the size of the investment portfolio at some point in the future.

As a result of the release of the pledged securities above and decreases in customer repurchase agreement balances, the amortized cost of securities pledged to public fund customers, the FRB discount window and customer repurchase agreements, decreased to $14.5 million from $20.2 million at year-end 2015.

Investment portfolio quality continues to receive scrutiny. The fair value of the portfolio is generally impacted by national and global economic news. During the first six months of the year, the portfolio’s fair value increased. At year-end there were net unrealized losses on the entire portfolio of $44,000 and at June 30, 2016 the portfolio had net unrealized gains of $165,000. Essentially during the first six months of 2016, the investment portfolio’s fair value improved by a net figure of $209,000. Although the investment portfolio has a net unrealized gain at June 30, 2016, there were four securities with an amortized cost of $1.3 million having an unrealized loss of $2,000. See Note 2 for information regarding this change as well as the Company’s assessment of other than temporary impairment on these investments.

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, 2016.

Loans held for sale activity during the first six months of 2016 included $2.8 million of loan originations and $2.7 million of sales. The associated gain on the loan sales was $71,000. The balance of loans held for sale at June 30, 2016 was $99,000. There were no loans held for sale at December 31, 2015.

Total loans (held for investment) increased $4.4 million and were $127.1 million at June 30, 2016 up from $122.7 million at December 31, 2015. The growth since 2015 occurred in the commercial and residential real estate segments and was offset somewhat by a decrease in the commercial segment. Although the local market is very competitive, management believes the Bank’s lending area is positioned to continue growing its loan portfolio in 2016 and will do so in a manner that assesses multiple risk factors in conjunction with expected rate of return and related capital allocation.

- 48 -

COMMUNITY SHORES BANK CORPORATION

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

Careful attention to the credit quality of the current portfolio as well as the expected growth will continue. The lending staff regularly monitors the loan portfolio and adheres to a well-designed credit risk assessment process. In spite of these efforts, 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.

The Bank has developed a detailed process to estimate credit risk. The process is discussed at length in Note 1 to the Company’s annual financial statements. At each period end, the balance in the allowance for loan losses is based on management’s estimation of probable incurred credit losses. The estimation is the result of loan portfolio analysis completed utilizing a detailed methodology prescribed in the Bank’s credit procedures.

The analysis of the allowance for loan losses is comprised of general credit allocations and specific credit allocations. General credit allocations are made to various categories of loans based on loan ratings, delinquency trends, historical loss experience as well as current economic conditions. The specific credit allocation includes a detailed review of a borrower and its entire relationship resulting in an allocation being made to the allowance for that particular borrower’s situation. 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, 2016, the allowance for loan losses totaled $1.6 million; nearly the same as at year-end 2015. The allowance for loan loss decreased by $33,000 and is the result of charge-offs of $131,000 and recoveries of $98,000 for the first six months of 2016. At June 30, 2016, the ratio of allowance to gross loans outstanding was 1.29% compared to 1.36% at year-end 2015. The decrease was attributable to an increase in loan balances as well as the net charge-offs in the first half of 2016.

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COMMUNITY SHORES BANK CORPORATION

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

The allocation of the allowance at June 30, 2016 and December 31, 2015 was as follows:

	June 30, 2016					December 31, 2015
			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	$	582,411		36.1	%	$	522,558		39.3	%
Commercial Real Estate		460,602		44.3			432,145		41.2
Consumer		263,890		5.4			322,185		5.6
Residential		211,914		14.2			210,653		13.9
Unallocated		119,764		N/A			183,875		N/A
Total	$	1,638,581		100.0	%	$	1,671,416		100.0	%

The general component of the allowance for loan losses as a percentage of non-specifically identified loans was 0.86% at June 30, 2016, a decrease of 3 basis points from year-end 2015. At June 30, 2016, there was approximately $120,000 of unallocated reserves in the allowance for loan losses while unallocated reserves were approximately $184,000 at December 31, 2015. In the second quarter of 2016, a portion of the unallocated reserves were used to increase the specific allocation of an individually identified loan.

At June 30, 2016, the allowance contained $491,000 in specific allocations for impaired loans whereas at December 31, 2015 there was $465,000 specifically allocated. In total, there was $8.3 million of recorded investment on impaired loans at June 30, 2016 compared to $8.7 million at year-end 2015. In the first half of 2016, several specifically identified loans were charged off.

Not all specifically identified loans require an allocation of reserves. After a loan is specifically identified and an evaluation of the collateral or expected repayment is completed, typically a charge-off is made so that the remaining principal is the current value of the assigned collateral or expected repayment, therefore no further reserve is required. There were 15 impaired loans requiring no reserve at June 30, 2016. At June 30, 2016, the recorded investment on impaired loans requiring no reserves was $6.8 million, or 82% of the recorded investment of specifically identified loans. This outcome is similar to $7.0 million requiring no reserves at year-end 2015 or 81% of the recorded investment of specifically identified loans.

Specifically identified loans requiring reserves had a recorded investment of $1.5 million June 30, 2016 and $1.7 million at year-end 2015. The decrease is partially a result of the charge-offs on specifically identified loans occurring since year-end 2015.

Another factor considered in the assessment of the adequacy of the allowance is the quality of the loan portfolio from a past due standpoint. Overall from year-end 2015 to June 30, 2016, the recorded investment in accruing past due and non-accrual loans didn’t change significantly because the increase in the recorded investment of past due loans still accruing interest was offset by a decrease in the recorded investment of non-accrual loans. The recorded investment in past due loans still accruing interest increased by $306,000 while the recorded investment in non-accrual loans decreased by $303,000 in the first six months of 2016.

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COMMUNITY SHORES BANK CORPORATION

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

The recorded investment of accruing loans past due 30-59 days was $685,000 at June 30, 2016; a $234,000 increase since December 31, 2015. There were five loans past due 30-59 days at June 30, 2016. One of the five loans had a recorded investment of $565,000. The loan has been identified as impaired since the fourth quarter of 2015 and carries a specific allocation in the allowance for loan losses. The Bank will continue to work closely with the borrower as they make plans to liquidate. The loan is guaranteed by the SBA which will limit the Bank’s ultimate exposure.

There recorded investment in loans past due 60-89 days still accruing interest was $178,000 at June 30, 2016 compared to a recorded investment of $106,000 at December 31, 2015. There were two loans past due at June 30, 2016, both loans were paid current in July.

There were no loans still accruing interest with a recorded investment past due 90 days and greater at either June 30, 2016 or December 31, 2015.

Although the Bank’s loan payment delinquency is low in both recorded investment and number of loans, the credit review process will continue to be stringent. Of course, it is possible that past due loan payments could fluctuate in future periods despite these efforts.

The recorded investment of non-accrual loans totaled $885,000 at June 30, 2016; down $303,000 from year-end 2015. The reduction was primarily concentrated in three loans. One loan was remediated and returned to an accruing status and two loans were charged off and the real estate collateral was moved to foreclosed assets. There are 5 non-accrual notes remaining at June 30, 2016 and no non-accrual notes are secured by undeveloped real estate. At June 30, 2016, there were specific allocations of $73,000 in the allowance for any estimated collateral deficiency on non-accrual loans.

There were net charge-offs of $33,000 for the first half of 2016 and the ratio of annualized net charge-offs was 0.05% to average loans. For the first half of 2015, there were net loan charge-offs of $405,000 and a ratio of annualized net charge-offs to average loans of 0.63%.

There were net charge-offs of $66,000 for the second quarter of 2016 and a ratio of annualized net charge-offs to average loans of 0.21%. For the second quarter of 2015, net charge-offs were $34,000 and the annualized ratio of net charge-offs to average loans was 0.11%.

A majority of the recorded charge-offs made in both years were related to specific allocations on previously impaired loans. In this case, increases to the ratios between the like periods are not necessarily indicative of deteriorating credit quality.

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COMMUNITY SHORES BANK CORPORATION

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

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

The loan maturities and rate sensitivity of the loan portfolio at June 30, 2016 are set forth below:

	Within		Three to		One to		After
	Three Months		Twelve Months		Five Years		Five Years		Total
Commercial	$	5,071,276	$	14,440,238	$	15,758,259	$	10,650,883	$	45,920,656
Commercial Real Estate:
General		2,446,267		7,526,091		34,336,047		6,995,309		51,303,714
Construction		146,000		1,669,585		2,025,657		1,114,260		4,955,502
Consumer:
Lines of credit		76,033		118,106		2,529,170		2,535,452		5,258,761
Other		39,540		55,671		845,790		226,147		1,167,148
Credit card		54,420		167,801		254,892		0		477,113
Residential		1,181,237		937,492		17,410		15,868,257		18,004,396
	$	9,014,773	$	24,914,984	$	55,767,225	$	37,390,308	$	127,087,290
Loans at fixed rates	$	3,904,774	$	8,455,756	$	46,859,346	$	26,426,121	$	85,645,997
Loans at variable rates		5,109,999		16,459,228		8,907,879		10,964,187		41,441,293
	$	9,014,773	$	24,914,984	$	55,767,225	$	37,390,308	$	127,087,290

At June 30, 2016, 67% of the Bank’s loan balances carried a fixed rate and 33% carried 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. 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, 2016, approximately 29% of the entire loan portfolio had a contractual maturity longer than five years; one basis point more than year-end 2015. 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. Over 40% of the loans in the greater than five year contractual maturity category are residential mortgage loans. Statistically, loans of this type do not normally remain on the books until maturity as a result of customer repricing opportunities or changes in circumstance. Additionally, the mortgage staff remains focused on originating loans saleable into the secondary market, thus minimizing the number that is booked into the held for investment portfolio. Another 32% of the total of loans with a contractual maturity of five years or more are guaranteed by government sponsored agencies; Small Business Administration (“SBA”) and United States Department of Agriculture (“USDA”). Of these loans, 97% are either variable rate or have a scheduled rate reset within five years, minimizing the extension risk.

¹ Extension risk, as related to loans, exists when booking fixed rate loans with long final contractual maturities. When a customer is contractually allowed longer to return 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

Foreclosed assets were $1.8 million at June 30, 2016; down over $400,000 since December 31, 2015. Foreclosed assets consist of relinquished properties through the collection process which were previously customer collateral supporting various borrowings. There were three property and five lot sales during the first six months of 2016. The net gain realized on these sales was $147,000. Two properties were added in the first half of 2016. At June 30, 2016, foreclosed assets consisted of 20 real estate holdings, one less than at December 31, 2015.

Deposit balances were $155.9 million at June 30, 2016 down from $161.2 million at December 31, 2015. The decline in deposit balances was most notably experienced in the time deposit category. Time deposits decreased by $8.0 million since year-end 2015. A majority of the maturities were internet time deposits. In the first six months of 2016, the Bank’s portfolio of internet time deposits decreased $8.2 million. The time deposit portfolio was deliberately contracted in an effort to reduce excess liquidity at the FRB. Offsetting a portion of the decrease in time deposits, savings account balances climbed $2.8 million since year-end 2015. The increase is from a variety of customers increasing their account balance since year-end 2015.

Repurchase agreement balances were $4.0 million at June 30, 2016 and $4.9 million at December 31, 2015, a decrease of $923,000. The decline between the two period ends was primarily the result of existing customers decreasing their balance.

The Company’s $1,280,000 note payable to 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 was extinguished on March 28, 2016 simultaneous to the closing of the Company’s Rights Offering. The balance of the note payable was settled in exchange for 670,153 and shares of stock issued to the members of 1030 Norton LLC and a check for $7.77 due to fractional shares. Upon consummation of the conversion, the Company made a final interest payment of $24,747 and 1030 Norton LLC released the Company’s pledge of 100% of the shares of Community Shores Bank.

In 2015, the Company recorded a derivative liability stemming from the conversion right embedded in the Company’s note payable to 1030 Norton LLC once the Company initiated a plan to raise capital via a sale of common stock. The value of the liability was established at $426,667, which represented a 25% per share discount on the stock to be issued in exchange for the outstanding note payable from the price per share of the Company established in the Rights Offering. Similar to the related note payable, the derivative liability, net of related deferred tax, was reclassified to shareholder’s equity at conversion on March 28, 2016.

Accrued interest expenses and other liabilities decreased $719,000 since year-end 2015. The decrease is mainly attributable to the Company’s repayment of deferred and overdue interest on its subordinated debentures. On March 30, 2016, utilizing proceeds from the Rights Offering, the Company remitted an interest payment of approximately $722,000; $673,000 of accrued interest and $49,000 of interest on the deferred interest curing the interest payment default.

On April 27, 2016, the Company’s Board of Directors voted to again defer interest payments on its subordinated debentures in order to preserve its cash for general operations and potential capital support for the Bank as it grows. As such, it is expected that the accrued interest balance will increase during the deferral period. The deferral of interest does not constitute an event of default.

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COMMUNITY SHORES BANK CORPORATION

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

Shareholders’ equity was approximately $14.1 million on June 30, 2016. On December 31, 2015, the balance was $7.6 million. The net increase of $6.5 million was made up of $6.3 million of new capital from common stock transactions, earnings of $55,000 and accumulated other comprehensive income (security market value adjustments) of $138,000.

The $6.3 million of additional capital stemmed from a series of transactions related to a Rights Offering launched by the Company in October 2015. The purpose of the Rights Offering was to increase the Company’s liquidity to allow repayment of the deferred and overdue interest on the Company’s subordinated debentures as well as allow a contribution of capital to the Bank so that it would achieve a well-capitalized regulatory capital level.

The Company sold a total of 1,383,299 shares of the Company’s Common Stock in the Rights Offering. The Company closed the Rights Offering on March 28, 2016 and garnered net proceeds of approximately $3,300,000.

Concurrent with the closing of the Rights Offering, the Company closed on the sale of 579,412 shares of Common Stock through a private placement, also at $2.55 per share. Total proceeds received from this transaction were approximately $1,500,000. There were no issuance costs associated with the private placements.

Additionally, the Rights Offering permitted the conversion feature of the Company’s note payable to activate. At the close of the Rights Offering, the note payable and the derivative liability, net of taxes, were settled in exchange for 670,153 shares of stock. This transaction added $1,561,000 to equity.

Total shares outstanding at June 30, 2016 were 4,101,664 compared to 1,468,800 at December 31, 2015. The book value per share was $3.43 at June 30, 2016 compared to $5.15 at December 31, 2015.

The largest portion of the Rights Offering proceeds was used to contribute capital to the Bank. On March 31, 2016, the Company contributed $3.35 million of capital to the Bank. As a result, the Bank’s regulatory capital ratio rose to a level of well capitalized according to prompt corrective action guidance. The Bank continues to be well capitalized and at June 30, 2016, the Bank’s total risk-based capital ratio was 11.57% and its Tier 1 to average assets ratio was 8.12% compared to 9.46% and 6.12%, respectively, at December 31, 2015.

RESULTS OF OPERATIONS

There was net income of $55,000 recorded for the first half of 2016. The corresponding basic and diluted income per share for the first six months of 2016 were $0.02. Conversely in the first half of 2015, there was a net loss of $200,000 stemming from a derivative valuation recognition of $427,000 recorded in the second quarter (see Note 12). The basic and diluted loss per share for the first six months of 2015 were $(0.14).

The Company had net income of $79,000 and basic and diluted earnings per share of $0.02 in second quarter of 2016. The net loss recorded for the second quarter of 2015 was $233,000, including the $427,000 derivative valuation recognition noted above. The corresponding basic and diluted loss per share for the second quarter of 2015 were $(0.16).

For the first six months of 2016, the annualized return on the Company’s average total assets was 0.06% compared to (0.22)% for the first six months of 2015. For the second quarter of 2016, the annualized return on the Company’s average assets was 0.17%. For the second quarter of 2015, the annualized return on the Company’s average total assets was (0.51)%.

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COMMUNITY SHORES BANK CORPORATION

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

The annualized return on the Company’s average equity was positive for the first half and second quarter of 2016 at levels of 0.99% and 2.25%, respectively. For the first half of 2015, the annualized return on the Company’s average equity was (4.92)% and was (11.45)% for the second quarter of 2015.

A primary component of the Company’s revenue is its net interest income. The Company’s net interest income was more for the first half of 2016 compared to the similar period in 2015 and the net interest margin was higher. The following table sets forth certain information relating to the Company’s consolidated average interest earning assets and interest bearing liabilities and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing annualized income or expenses by the average daily balance of assets or liabilities, respectively, for the periods presented.

	Six Months ended June 30,
	2016							2015
	Average				Average			Average				Average
	Balance		Interest		Rate			Balance		Interest		Rate
Assets
Federal funds sold and interest- bearing deposits with banks	$	16,909,157	$	42,132		0.50	%	$	6,648,108	$	7,775		0.23	%
Securities		23,578,293		160,064		1.36			30,589,180		216,892		1.42
Loans (including held for sale and non accrual)		124,633,141		3,095,809		4.97			129,193,434		3,260,330		5.05
Total interest earning assets		165,120,591		3,298,005		3.99			166,430,722		3,484,997		4.19
Other assets		17,004,349							17,562,596
	$	182,124,940						$	183,993,318
Liabilities and Shareholders’ Equity
Interest-bearing deposits	$	124,949,733	$	318,849		0.51	%	$	128,210,353	$	336,092		0.52	%
Repurchase agreements		4,021,460		8,299		0.41			6,558,057		14,707		0.45
Subordinated debentures and note payable		5,111,868		91,894		3.60			5,780,000		538,690		18.64
Total interest bearing liabilities		134,083,061		419,042		0.63			140,548,410		889,489		1.27
Non-interest-bearing deposits		36,112,403							34,431,323
Other liabilities		944,123							873,943
Shareholders’ Equity		10,985,353							8,139,642
	$	182,124,940						$	183,993,318
Net interest income (tax equivalent basis)				2,878,963							2,595,508
Net interest spread on earning assets (tax equivalent basis)						3.36	%						2.92	%
Net interest margin on earning assets (tax equivalent basis)						3.49	%						3.12	%
Average interest-earning assets to average interest-bearing liabilities						123.15	%						118.42	%
Tax equivalent adjustment				732							9,869
Net interest income			$	2,878,231						$	2,585,639

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COMMUNITY SHORES BANK CORPORATION

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

The net interest spread on average earning assets increased 44 basis points to 3.36% in the past twelve months. The net interest margin increased by 37 basis points and was 3.49% for the first six months of 2016 compared to 3.12% for the first six months of 2015. The net interest income for the first six months of 2015 was $2.6 million compared to a figure of $2.9 million for the same six months in 2016. The derivative valuation adjustment lowered 2015’s results by $427,000. Without the recognition, the net interest income would have been $144,000 more than the net interest figure for the first six months of 2016. The reduction in net interest income is mostly due to fewer earning assets and a less profitable mix. For the first half of 2016, average earning assets were $1.3 million less than the first half of 2015 and the loan and investment portfolios were $11.6 million less while interest bearing deposits with other financial institutions, mainly the FRB, was $10.3 million more.

The average rate earned on interest earning assets was 3.99% for the six month period ending June 30, 2016; a 20 basis point erosion compared to 4.19% for the same period in 2015. The decrease was primarily due to detrimental changes to the earning asset composition. Specifically, investments were reduced by 4% and loans were reduced by 2% over the last twelve months. Changes to the loan portfolio impact net interest income more than anything else since it is the Company’s largest earning asset category. The $4.6 million reduction in the loan portfolio stemmed from customer repayments. In addition to a smaller loan portfolio, there was also a reduction in the yield. As the credit markets recover, financial institutions are more actively soliciting new business making the rate environment more competitive. In order to retain current relationships and attract new ones, sometimes the Bank has to offer rates that are lower than the average portfolio rate. The average rate earned on the loan portfolio was 4.97% in the first half of 2016, a reduction of eight basis points compared to the first half of 2015. Lower rates are not being automatically offered on renewals or new business. To maintain the quality of the loan portfolio, each rate decision takes into consideration the strength of the loan from an underwriting standpoint. Lower rates are used selectively based on the risk characteristics of the credit.

Without the additional $427,000 of interest expense on the note payable, the Company’s cost of funds would have improved by three basis points when compared to the first half of 2015.

Driving the reduction, was the elimination of the Company’s note payable in the first quarter of 2016 (see Note 11). The note payable carried an interest rate of 8%. The Company continues to decrease the rate paid on interest bearing deposits by focusing on a reduction in the concentration of internet time deposits. In the first half of the year, internet time deposits decreased by $8.2 million. The average rate on these maturities was 0.85%.

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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, 2016 and 2015 is in the table below.

	Three Months ended June 30,
	2016							2015
	Average				Average			Average				Average
	Balance		Interest		Rate			Balance		Interest		Rate
Assets
Federal funds sold and interest-
bearing deposits with banks	$	17,814,778	$	22,256		0.50	%	$	6,000,739	$	3,481		0.23	%
Securities		22,600,465		74,625		1.32			29,734,692		101,400		1.36
Loans (including held for sale and non accrual)		125,269,863		1,575,056		5.03			128,285,507		1,603,651		5.00
Total interest earning assets		165,685,106		1,671,937		4.04			164,020,938		1,708,532		4.17
Other assets		16,724,652							17,626,546
	$	182,409,758						$	181,647,484
Liabilities and Shareholders’ Equity
Interest-bearing deposits	$	123,583,503	$	157,311		0.51	%	$	126,455,389	$	162,710		0.51	%
Repurchase agreements		3,837,362		3,900		0.41			5,824,862		6,159		0.42
Subordinated debentures and note payable		4,500,000		31,417		2.79			5,780,000		483,156		33.44
Total interest bearing liabilities		131,920,865		192,628		0.58			138,060,251		652,025		1.89
Non-interest-bearing deposits		35,973,170							34,261,971
Other liabilities		506,337							1,204,001
Shareholders’ Equity		14,009,386							8,121,261
	$	182,409,758						$	181,647,484
Net interest income (tax equivalent basis)				1,479,309							1,056,507
Net interest spread on earning assets (tax equivalent basis)						3.46	%						2.28	%
Net interest margin on earning assets (tax equivalent basis)						3.57	%						2.58	%
Average interest-earning assets to average interest-bearing liabilities						125.59	%						118.80	%
Tax equivalent adjustment				0							4,296
Net interest income			$	1,479,309						$	1,052,211

Net interest income increased $427,000 in the second quarter of 2016 over the similar period in 2015. The derivative valuation recognition recorded in the second quarter of 2015 was also $427,000. Essentially, net interest income would have been the same for both second quarter periods of 2016 and 2015 except for the derivative valuation recognition. The additional interest expense recorded when the derivative liability was recognized in the second quarter of 2015 significantly impacted the net interest income ratios. The net interest spread for the three month period ending June 30, 2015 was just 2.28% compared to 3.46% in the second quarter of 2016 when there was no derivative liability recognition.

Similarly, the net interest margin for the second quarter of 2015 was 99 basis points lower when compared to the second quarter in 2016. The net interest margin for the second quarter of 2015 was 2.58% compared to 3.57% for the second quarter of 2016.

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COMMUNITY SHORES BANK CORPORATION

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

The yield on earning assets fell 13 basis points between the second quarter of 2015 and the second quarter in 2016. Again, a decrease in the loan portfolio played a part in the adverse outcome. On average the loan portfolio was $3.0 million less in the second quarter of 2016 compared to the second quarter of 2015. Nonetheless, an even larger impact was made by the increase in the concentration of interest bearing deposits with other financial institutions. This earning asset category increased from 4% of average earning assets in the second quarter of 2015 to 11% of total average earning assets in 2016. Interest bearing deposits with other financial institutions is the lowest yielding category.

The derivative valuation recognition in the second quarter of 2015 added $427,000 of interest expense. Without the additional $427,000 of interest expense on the note payable, the Company’s cost of funds would have improved by seven basis points when compared to the first half of 2015. Similar to the six month outcome, the second quarter cost of funds benefitted from the elimination of the 8% note payable.

Management expects the Company’s net interest margin to increase in the remaining quarters of 2016. Extra liquidity in interest bearing deposits with other financial institutions should ease in the second half of 2016 as the Bank funds loans and repays maturing internet time deposits. If implemented as planned, these tactics should provide a favorable movement in the concentration of earning assets as well as lower the Company’s cost of funds.

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, 2016 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	$	14,041,580		$	0		$	0	$	0	$	14,041,580
Securities (including FHLB stock)		2,778,417			6,800,520			11,874,786		201,150		21,654,873
Loans held for sale		0			0			0		99,000		99,000
Loans		44,523,478			14,536,226			48,663,683		19,363,903		127,087,290
		61,343,475			21,336,746			60,538,469		19,664,053		162,882,743
Interest-bearing liabilities
Savings and checking		88,512,380			0			0		0		88,512,380
Time deposits <$100,000		2,637,997			9,289,199			9,199,179		0		21,126,375
Time deposits >$100,000		1,366,757			3,900,530			4,411,713		0		9,679,000
Repurchase agreements and Federal funds purchased		3,997,075			0			0		0		3,997,075
Notes payable and other borrowings		4,500,000			0			0		0		4,500,000
		101,014,209			13,189,729			13,610,892		0		127,814,830
Net asset (liability) repricing gap	$	(39,670,734	)	$	8,147,017		$	46,927,577	$	19,664,053	$	35,067,913
Cumulative net asset (liability) repricing gap	$	(39,670,734	)	$	(31,523,717	)	$	15,403,860	$	35,067,913

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. Recent interpretation of the information from the Federal Open Market Committee of the Federal Reserve System has leaned towards raising rates; because the Company’s gap position is negative, 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. The local market rates often play a large part in the movement of rates on liabilities.

There was no provision for loan losses for the first six months of 2016 or 2015. The provision expense is associated with changes in historical loss calculations, economic conditions (local and national) as well as delinquency, net charge offs or recoveries and changes to credit quality grades; up and down. A methodical assessment of these factors generates the reserves required for the risk in the Bank’s loan portfolio and the required provision expense. Management will continue to review the allowance with the intent of maintaining it at an appropriate level for the portfolio’s credit quality and perceived risk factors. The provision for loan losses is an estimate and may be increased or decreased in the future.

Non-interest income recorded in the first six months of 2016 was $855,000 compared to $844,000 recorded for the similar period in 2015.

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COMMUNITY SHORES BANK CORPORATION

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

Non-interest income for the second quarter of 2016 was $473,000 compared to $437,000 of non-interest income in the second quarter of 2015.

Although both quarterly and year-to-date results for non-interest income were similar in total, there were differences in the components. Non-interest income for the second quarter and six month periods of 2016 included lower overdraft revenue and higher gains on foreclosed asset sales. Overdraft revenue has been declining since 2015. There are many theories surrounding the reduction, including a stronger local economy. Management is currently reviewing other deposit account fees to see if anything can be changed to help replace the declining revenue from overdrafts. Foreclosed asset gains are not predictable and will likely decline as the Bank’s inventory of foreclosed properties diminishes.

Non-interest expenses for the first half of 2016 were $3.7 million; $77,000 less than the total for the first half of 2015. Similarly, non-interest expenses were $4,000 lower for the second quarter of 2016 compared to the second quarter of the previous year.

Data processing expenses were $239,000 for the first half of 2016. These expenses were $337,000 in the first half of 2015. Late in the second quarter of 2015, the Bank renegotiated its core data processing contract. The lower fee schedule began in the third quarter of 2015 and will be in effect for 72 months. The first half of 2016 reflected a $98,000 savings over the same period in 2015 due to the new fee schedule. Management anticipates that the savings over the life of the contract will be over $1.8 million at the Bank’s current size and mix of electronic products. These savings could be offset by growth in the customer base as well as the addition of new technology. Data processing expenses were $120,000 for the second quarter of 2016; $51,000 less than for the same period in 2015 due to the same reason as explained above.

Professional services expenses for the first half of 2016 were $222,000; $41,000 more than the total for the first half of 2015. The Bank’s audit expense has increased compared to prior years and there were additional audit expenses associated with the work required to restate its 2014 audited financial statements.

FDIC insurance expenses were $128,000 for the first half of 2016 and $203,000 for the first half of 2015. The $75,000 reduction in the Bank’s FDIC premium accruals were due to a strengthened regulatory capital position and improved risk profile. Management expects to see a further reduction in FDIC premiums as a result of the Bank’s regulatory capital ratios and the recent $3.35 million capital infusion from the Company. FDIC insurance expenses were $60,000 for the second quarter of 2016 compared to $102,000 for the second quarter of 2015.

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COMMUNITY SHORES BANK CORPORATION

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, 2016. 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, 2016.

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

None.

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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

The Exhibit Index following the signature page hereto is incorporated by reference under this item.

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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 15, 2016	By:	/s/ Heather D. Brolick
Date	Heather D. Brolick
	President and Chief Executive Officer
	(principal executive officer)

August 15, 2016	By:	/s/ Tracey A. Welsh
Date	Tracey A. Welsh
	Senior Vice President, Chief Financial Officer, Secretary 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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