COMMUNITY SHORES BANK CORP - FORM 10-K - EX-13 - EXHIBIT 13

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EX-32.2 - EXHIBIT 32.2 - COMMUNITY SHORES BANK CORP	v462765_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - COMMUNITY SHORES BANK CORP	v462765_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - COMMUNITY SHORES BANK CORP	v462765_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - COMMUNITY SHORES BANK CORP	v462765_ex31-1.htm
EX-23.1 - EXHIBIT 23.1 - COMMUNITY SHORES BANK CORP	v462765_ex23-1.htm
EX-21 - EXHIBIT 21 - COMMUNITY SHORES BANK CORP	v462765_ex21.htm
EX-14 - EXHIBIT 14 - COMMUNITY SHORES BANK CORP	v462765_ex14.htm
EX-10.5 - EXHIBIT 10.5 - COMMUNITY SHORES BANK CORP	v462765_ex10-5.htm
10-K - 10-K - COMMUNITY SHORES BANK CORP	v462765_10k.htm

EXHIBIT 13

COMMUNITY SHORES

BANK

CORPORATION

2016 ANNUAL REPORT

DECEMBER 31, 2016

Selected Financial Information

As of or for the Year-Ended December 31,	2016			2015			2014
(dollars in thousands, except per share data)
Results of Operations:
Net interest income	$	5,913		$	5,510	²	$	6,158
Provision for loan losses		0			0			0
Non-interest income		1,580			1,659			1,731
Non-interest expense		7,251			7,835			7,595
Income (loss) before income tax		242			(666	)		294
Income tax expense (benefit)		79			(226	)		(3,717	)
Net income (loss)		163			(440	)		4,011

Financial Condition:
Total assets		191,410			181,021			184,677
Loans held for sale		128			0			148
Loans		140,825			122,742			129,787
Allowance for loan losses		1,612			1,671			1,978
Securities		15,766			25,210			31,691
Deposits		167,723			161,182			161,305
Repurchase agreements		4,640			4,921			8,611
Notes payable and other borrowings		4,500			5,780			5,780
Shareholders' equity		14,061	¹		7,562			8,081

Performance Ratios:
Return (loss) on average assets		0.09	%		(0.24	)²%		2.08	%
Return (loss) on average shareholders' equity		1.30	¹		(5.50	)²		99.65
Net interest margin		3.55			3.28	²		3.44
Per Share Data:
Earnings (loss) per share - basic	$	0.05		$	(0.30	)²	$	2.73
Earnings (loss) per share - diluted		0.05			(0.30	)²		2.73
Book value per share		3.43			5.15			5.50
Capital Ratios of Bank:
Tier 1 risk-based capital		10.03	¹%		8.22	%		7.58	%
Total risk-based capital		11.12	¹		9.46			8.83

¹Includes proceeds of $4,767 from capital raise – see Note 12 to the Consolidated Financial Statements.

²Includes derivative recognition of ($427) or ($0.29) per share – see Note 11 to the Consolidated Financial Statements.

Dear Fellow Community Shores Shareholder,

The year 2016 was pivotal for Community Shores. Having completed capital raising efforts and injecting $3.475 million to the Bank in 2016, we began the earnest work of delivering upon our commitment to put those funds to good use. Recognizing the need to rebuild and reverse a seven year history of “shrinking the Bank,” we began the process of deploying funds toward healthy earning asset growth. Changes were made within our lending staff and a strong business development effort was established. We are pleased to report that we capitalized on opportunities and our strategies met with success. Positive balance sheet changes were realized. We increased the total loan portfolio by 15% or $18.1 million over year-end 2015. A stark contrast and strong reversal to the loan portfolio attrition of 5% or $7 million experienced in fiscal year 2015.

Increasing earning assets is strategic to improving revenue generation, and we are excited by this initial success. Yet we remain very cognizant of credit quality; its maintenance during periods of growth is critical. Adhering to that principle, approximately 84% of the new commercial loan outstandings booked are considered “above average” based on our internal loan rating system. We continue to invest in robust external loan reviews and audits, and maintain sound internal credit administration policies and procedures. Industry, loan type, extension risk, history, management and cost verses return on capital are all factors at the forefront of our credit decision making process.

Under strong credit administration, we believe our new loan quality is high and our overall loan portfolio is sound and continues to improve. All of our asset quality metrics have continued to trend positively. Non-performing assets declined for the 8^th consecutive year to $2.7 million, representing a 33% decrease over year-end 2015. Past due and non-accrual loans at year-end 2016 were 0.94% of total loans and continue to remain below our FDIC peer group at 1.56%. Classified assets to total assets decreased 12%, with total classified assets declining to $5.1 million, showing marked improvement. While the list of problem credits has significantly diminished, performing, older, pre-crisis loans have not rehabilitated sufficiently for upward migration. We continue to work hard with these clients and are targeting another 6% reduction by year-end 2017.

On the liability side of the balance sheet, we saw total deposits increase 4% or $7 million over year-end 2015. The deposit mix has favorably changed with demand deposits increasing 20%; interest bearing accounts increasing 11%; and regular savings deposits growing 34% since the prior year end. Our liquidity position is strong and we are well positioned to fund future loan growth with existing, lower costing deposits.

Bank earnings slightly exceeded our expectations at $466,000 pre-tax, with net income on a consolidated basis at $163,000. Our cost of funds did not increase in the wake of the first prime rate increase in seven years on December 17, 2015. Interest expense to average earning assets was the lowest in our 18 year history at 0.39%, and for the first time was below the FDIC peer group at 0.40%. Conversely, and indicative of our market’s competitive rate environment, the Bank’s interest income to average earning assets did not increase. On a consolidated basis, primarily due to the elimination of the Company’s senior debt, the net interest margin on earning assets improved 27 basis points from year-end 2015. The positive changes in our balance sheet, combined with anticipated, incremental upward movement in net interest margin throughout 2017, should provide for net revenue improvement.

We will gain efficiency as we grow assets while continuing to control expenses. We made progress in 2016 decreasing the Bank’s non-interest expenses, by $574,000 compared to year-end 2015. Despite a 53% improvement in the gain on sale of mortgages, non-interest income, excluding losses on the sale of foreclosed property, remained relatively flat at $1.2 million. As with most banks, non-interest income was negatively impacted by regulations on the assessment of overdraft fees. In an effort to offset this loss of fee income, in March of 2017 we revised our checking account product offerings and expect to see positive change over the next 24 months.

We reached another milestone on March 16, 2017 with the termination of the Company’s Written Agreement with the Federal Reserve Bank. We are committed to insuring the Company has adequate resources to act as a source of strength to the Bank. Community Shores is well capitalized and our goal is to achieve budgeted growth through earnings. At the same time, we recognize that operating momentum and market opportunities should be acted upon in order to expedite an acceptable return on equity. For that reason, your Board of Directors is monitoring business opportunities and capital resources on a monthly basis as part of our capital management and planning process.

In the community, we have experienced renewed support and a resurgence of business opportunities. We believe this to be the result of our successful re-capitalization and release of the Bank’s Consent Order, and to the number of community bank acquisitions that have recently changed the face of banking in our market area. We have benefited by having experienced and talented sales people join our team, and by the void created when seasoned and professional bankers left the industry and exited the marketplace. Our prospects are extensive and we intend to work hard to gain market share and develop new client relationships.

While we are rebuilding, we remain focused on creating value. We have a committed team of invested Directors and talented, professional bankers all of whom value west Michigan as their home; bankers that want to help customers achieve their financial goals and their own unique vison of success. Because we are passionate about making our local communities economically vibrant; because we believe integrity, hard work and service to others speaks for itself; because we have Stockholders, Directors and customers that share our values and have supported us indefatigably, we are confident that we will achieve our goals and exceed expectations in the coming year.

Thank you for your investment and continued support. We hope that you will be able to join us at this year’s annual shareholder meeting on Wednesday, May 24th at 9:00 a.m. at the Muskegon Country Club.

	Sincerely,

	/s/ Heather D. Brolick
	Heather D. Brolick
	President and Chief Executive Officer

COMMUNITY SHORES BANK CORPORATION

Muskegon, Michigan

2016 ANNUAL REPORT

CONTENTS

MANAGEMENT’S DISCUSSION AND ANALYSIS		1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM		28

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS		29

CONSOLIDATED STATEMENTS OF INCOME (LOSS)		30

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)		31

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY		32

CONSOLIDATED STATEMENTS OF CASH FLOWS		33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS		34

SHAREHOLDER INFORMATION		84

DIRECTORS AND OFFICERS		86

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

INTRODUCTION

Community Shores Bank Corporation (“the Company”) is a Michigan corporation and is the holding company for Community Shores Bank (“the Bank”). The Bank owns all of the outstanding capital stock of Community Shores Mortgage Company (“the Mortgage Company”). The Mortgage Company has one wholly-owned subsidiary, Berryfield Development, LLC (“Berryfield”). On September 27, 2002, the Company created Community Shores Financial Services (“CS Financial Services”). In December 2004, a business trust subsidiary was formed called Community Shores Capital Trust I (“the Trust”).

The Bank commenced operations on January 18, 1999. The Bank is a Michigan chartered bank with depository accounts insured by the Federal Deposit Insurance Corporation (“FDIC”). The Bank currently has four locations and provides a full range of commercial and consumer banking services in Muskegon County and Northern Ottawa County, Michigan.

The Mortgage Company, a wholly-owned subsidiary of the Bank, was formed on March 1, 2002 by transferring a majority of the Bank’s commercial and residential real estate loans at that date in exchange for 100% of the equity capital of the Mortgage Company. On the day of formation, the Mortgage Company commenced operations and became legally able to originate residential mortgage loans. The Bank services all of the portfolio loans held by the Mortgage Company pursuant to a servicing agreement. Management chose to form the Mortgage Company to provide better customer service and to increase the profitability of the mortgage function as well as the consolidated Company.

Berryfield, a wholly-owned subsidiary of the Mortgage Company, is a limited liability company that was created in October 2010. The entity’s sole purpose is to oversee the development and sale of vacant lots that have been foreclosed on by the Mortgage Company.

In December of 2004, the Company formed Community Shores Capital Trust I, a Delaware business trust. The Trust is administered by a Delaware trust company, and two individual administrative trustees who are employees and officers of the Company. The Trust was established for the purpose of issuing and selling its preferred securities and common securities and used the proceeds from the sales of those securities to acquire subordinated debentures issued by the Company. A majority of the net proceeds received by the Company was used to pay down the outstanding balance on the Company’s line of credit. The remaining proceeds were used to contribute capital to the Bank as well as support the general operating expenses of the Company, including the debt service on the Company’s subordinated debentures.

In the first quarter of 2016, the Company successfully completed a Rights Offering which commenced in the fourth quarter of 2015 and a concurrent private placement (See Note 12). On March 28, 2016, after receiving Federal Reserve Bank of Chicago (“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.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

The Company was subject to a Written Agreement with the FRB beginning in December 2010 but in light of improvements to the Company’s financial condition and the strengthened capital position of the Bank as a result of the capital raise, the FRB terminated the Written Agreement on March 16, 2017.

Going forward, the FRB has requested that the Company obtain written approval at least 30 days prior to declaring or paying a dividend on any class of its stock; increasing its debt, including the issuance of trust preferred securities; or redeeming any Company stock.

As of December 31, 2016, the Bank had 51 full-time employees and 23 part time employees, an increase of one full-time equivalent position since December 31, 2015.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The purpose of this section of the Annual Report is to provide a narrative discussion about the Company’s financial condition and results of operations during 2016. The “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as disclosures found elsewhere in the Annual Report are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Our significant accounting policies are discussed in detail in Note 1 of the Notes to the Consolidated Financial Statements. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.

We view critical policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions and where changes in those estimates and assumptions could have a significant impact on the financial statements. We believe our critical accounting policies include determining the allowance for loan losses, the fair value of financial instruments, the carrying value of foreclosed assets and the realization of deferred tax assets. A description of the critical policies is as follows. Actual results could differ from the estimate.

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

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

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

Fair Value of Financial Instruments. Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a Note 20. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect these estimates.

Foreclosed Assets. Foreclosed assets are acquired through or instead of loan foreclosure and are initially recorded at fair value less estimated selling costs when acquired, establishing a new cost basis. During the time that foreclosed assets are waiting to be sold, there will be occasions that the Bank will need to re-evaluate the individual market values of each asset. If there is evidence that the fair value has declined since the last evaluation, the Bank will incur an impairment charge in order to properly reflect the estimated fair value of the asset at the end of the reporting period. The Bank’s Credit Department analyzes foreclosed asset values on a quarterly basis, to determine the value at which they should be held.

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

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

In determining potential realization of deferred tax assets, future taxable income from operations is considered. The taxable income used is in the analysis is exclusive of temporary difference reversals and tax planning strategies that could be implemented , if necessary, to accelerate taxable income into periods in which net operating losses might otherwise expire.

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company had no unrecognized tax positions at either 2015 or 2016 year-end.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

FORWARD-LOOKING STATEMENTS

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

Future factors include, among others, changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulation or actions by bank regulators; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; changes in the national and local economy; the 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; 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.

OVERVIEW

In the first quarter of 2016, the Company closed a Rights Offering and concurrent private placement garnering net proceeds, after expenses, of approximately $4.77 million. With the proceeds, the Company repaid the deferred and overdue interest on the trust preferred securities totaling approximately $722,000; made capital contributions to the Bank of approximately $3.48 million; and retained the remainder for the Company’s general operations. These transactions are described in more detail in Note 12 to the Consolidated Financial Statements.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

On March 31, 2016, the Company made a capital contribution of $3.35 million to the Bank elevating its capital ratios 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 according to prompt corrective action regulatory guidance. A second contribution of capital was made on September 30, 2016 for $125,000.

Including the balance sheet changes resulting from the capital raise, total assets grew by 5.7% ending the year at $191.4 million. Asset growth was driven by an $18.1 million increase in the loan portfolio. The loan growth was funded by a reduction in the security portfolio as well as a $6.5 million increase in deposits. Earnings for 2016 were also favorable. Recorded net income was $163,000.

FINANCIAL CONDITION

Total assets increased by $10.4 million to $191.4 million at December 31, 2016 from $181.0 million at December 31, 2015. The year-over -year change in assets was evidenced by an increase in cash and loans and a decrease in investments.

Cash and cash equivalents increased by $3.2 million to $21.1 million at December 31, 2016 from $17.9 million at December 31, 2015. The increase was from higher balances on deposit at the FRB and Federal Home Loan Bank of Indiana (“FHLB”) on the last business day of 2016 compared to the last business day of 2015. The FRB balance at year-end 2016, $16.6 million, was $1.5 million more than year-end 2015. In recent years, the Bank’s average balance at the FRB has grown. The growth is attributable to a larger core deposit base. Management’s desired balance at the FRB is a range of $7 to $10 million. The preferred range is generally enough to cover the typical liquidity needs of the Bank’s operations as well as provide a surplus for unexpected events. The FHLB balance was $1.1 million at year-end 2016; $1 million higher than year-end 2015. The inflated balance was the result of one security in safekeeping at the FHLB maturing on the last day of the year. The excess liquidity at year-end 2016 is expected to be used to fund loans and purchase securities.

The Bank’s available for sale security portfolio was $15.8 million at December 31, 2016 and $25.2 million at December 31, 2015. At both December 31, 2016 and 2015, there were no securities classified as held to maturity. Investment activity for 2016 consisted of maturities, prepayments and calls totaling $9.3 million and net amortization and fair value increase of $191,000.

Although the investment portfolio is declining in balance, 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.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

At December 31, 2016, 10% of the investment portfolio was unencumbered compared to 20% at December 31, 2015. Management intentionally reduced the pledged component of the investment portfolio due to a $4 million reduction in the Bank’s pledging requirements. This action was driven by a reduction in pledging obligations which occurred in the second quarter of 2016. In that quarter, pledging for two of the Bank’s public fund customers was eliminated. The pledging was offered during the time the Bank was operating under a Consent Order with the FDIC which was terminated in December 2015. Management chose to reduce the size of the investment portfolio as securities matured in an effort to fund loan growth. Management will purchase securities in the first quarter of 2017 in order to maintain the unencumbered portion of the portfolio within the specified range.

As a result of the release of the pledged securities above, the amortized cost of securities pledged to remaining public fund customers, the Discount Window and customer repurchase agreements, decreased to $14.3 million from $20.2 million at year-end 2015.

In the financial services industry, investment portfolio quality typically receives scrutiny when instruments within the portfolio are higher risk. The Bank monitors the quality of the Company’s portfolio actively however the instruments held by the Company are deemed to be traditional and conservative from a risk standpoint; nonetheless, the fair value of even those investments can be impacted by national and global economic news. During 2016, the portfolio’s fair value increased but the entire portfolio still carried a net unrealized loss. At year-end 2016, there were net unrealized losses of $34,000. At year-end 2015, there were net unrealized losses on the entire portfolio of $44,000; a decrease of $10,000. At December 31, 2016, there were 17 securities with an amortized cost of $6.9 million having an unrealized loss of $90,000. None of the 17 is deemed to be other-than-temporarily impaired. See Note 2 for information regarding 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 December 31, 2016.

Loans held for sale were $128,000 at year-end 2016. There were no loans held for sale at year-end 2015. The absolute change between the year-end periods was insignificant; however, during the twelve months of 2016 the activity included $7.6 million of loan originations and $7.3 million of loan sales. The associated gain on the loan sales was $189,000.

Loans held in portfolio were increased by $18.1 million; the commercial and commercial real estate segments increased by $15.9 million, total consumer loans increased by $649,000 and total residential loans grew $1.6 million. The distribution of the Bank’s loan portfolio remains representative of the wholesale focus which has been upheld since the Bank’s opening in 1999. The commercial and commercial real estate segments represented 81% of the Bank’s total loan portfolio at December 31, 2016; a small increase from an 80% level held by these two segments at December 31, 2015.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

The growth in the commercial and commercial real estate segments was comprised of a $2.6 million increase in the commercial portfolio and a $13.3 million increase to the commercial real estate portfolio. Management believes the Bank is well-positioned to continue expansion of these portfolios in 2017. The growth in consumer loans during 2016 was due to a home equity loan promotion that was conducted in the second half of 2016. The promotion involved waiving fees for new customers qualifying for a home equity loan under $100,000. Some additional growth may occur from this program in 2017.

Since the Bank focuses on originating salable residential loans, historically it has not been common to have growth of $1.6 million in residential loans a single year. Growth in 2016 stems primarily from two loans that were originated for well-qualified customers that were too large to qualify for the standard programs the Bank has established with its mortgage loan investors. The Bank does not anticipate meaningful residential segment growth in 2017. The 15% year-over-year portfolio loan growth was believed to be conducted in a manner that assessed multiple risk factors in conjunction with expected rate of return and related capital allocation; the same principles that will be used for future loan growth.

Diligent credit oversight for the past several years played a large part in reducing the Bank’s credit risk, which in turn was a significant factor in improving the Bank’s overall regulatory risk profile. Essentially, credit risk is the risk of borrower nonpayment typically on loans although it can be applicable to the investment portfolio as well. There are ways to decrease this risk however; the risk of nonpayment for any reason exists with respect to all loans and investments. Management intends to adhere to its established underwriting standards, even as lending competition intensifies in the local market, and will pursue growth based on the quality of its relationships and connections in the community.

The Bank’s credit program is led by an experienced officer of the Bank. Credit administration entails assessing, monitoring and estimating credit risk. The credit administration process includes bi-weekly meetings with loan personnel to discuss identified weak credits and periodic meetings specifically for the purpose of conducting an internal loan review. To supplement the internal processes, an annual credit review is conducted by an independent accounting firm. Even with stringent oversight, 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.

To estimate probable incurred credit losses and determine the proper allowance for loan loss level to absorb the loss, the Bank utilizes a detailed process. The process is discussed at length in Note 1 to the Company’s financial statements. At each period end, the balance in the allowance for loan losses is assessed for adequacy.

The analysis of the allowance for loan losses is comprised of three portions: general credit allocations, specific credit allocations and unallocated. General credit allocations are made to various categories of loans based on loan ratings, delinquency trends, historical loss experience as well as current economic conditions. The specific credit allocation includes a detailed review of a borrower and its entire relationship resulting in an allocation being made to the allowance for that particular borrower. A loan becomes specifically identified when, based on current information and events related to that particular borrower, it is probable that the Company will be unable to collect the scheduled payments of principal and interest according to the contractual terms of the loan agreement. Specifically identified loans are individually evaluated for impairment.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

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 December 31, 2016, the allowance for loan losses totaled $1.6 million. At year-end 2015, the allowance for loan losses was $1.7 million. The decrease in the allowance is the result of net loan charge-offs of $60,000 for the twelve month period of 2016.

The total of all allocations included in the allowance by loan segment at December 31, 2016 and 2015 was as follows:

	2016					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	$	617,002		36.1	%	$	522,558		39.3	%
Commercial Real Estate		459,805		45.3			432,145		41.2
Consumer		259,194		5.4			322,185		5.6
Residential		203,312		13.2			210,653		13.9
Unallocated		72,507		N/A			183,875		N/A
	$	1,611,820		100.0	%	$	1,671,416		100.0	%

At December 31, 2016, the ratio of allowance to gross loans outstanding was 1.14% compared to 1.36% at year-end 2015. The reduction in this ratio is due mostly to the growth in the loan portfolio. The allowance for loan losses was able to accommodate the growth due to the unallocated portion. The unallocated balance in the allowance for loan loss total was reduced by $111,000 since year-end 2015.

The general component of the allowance for loan losses increased by $85,000 since year-end 2015; however, the general reserves as a percentage of non-specifically identified loans decreased by five basis points. At December 31, 2016, the general component of the allowance for loan losses as a percentage of non-specifically identified loans was 0.84% but at December 31, 2015, the ratio was 0.89%. The change between the two year-end periods is due to a shift in the distribution of the loan portfolio. A majority of the year-over-year growth came from loans originated in risk categories that require smaller allocations within the allowance for loan losses. See Note 3 to the financial statements for a comparison of the distribution of the commercial and commercial real estate loans by risk category.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

At December 31, 2016, the allowance contained $432,000 in specific allocations for impaired loans whereas at December 31, 2015 there was $465,000 specifically allocated; a decrease of $33,000. Conversely, the recorded investment of impaired loans increased since year-end 2015. The recorded investment of impaired loans was $9.3 million at December 31, 2016 compared to $8.7 million at year-end 2015. The decrease in specific allocations was driven by a $178,000 decrease in specifically identified impaired loans requiring reserves. At December 31, 2016, the recorded investment of specifically identified impaired loans requiring reserves was $1.5 million compared to $1.7 million at December 31, 2015.

Not all impaired loans require a specific allocation of reserves. Since year-end 2016, specifically identified impaired loans requiring no reserves rose to 84% of the recorded investment of total specifically identified impaired loans at December 31, 2016; up from 81% at year-end 2015. At December 31, 2016, the recorded investment on specifically identified impaired loans requiring no reserves was $7.8 million, an increase of $795,000 since year-end 2015. There were 14 impaired loans requiring no reserve at December 31, 2016, down from 16 at same period end in 2015.

The methodology used to determine the adequacy of the allowance for loan losses is consistent with the prior year. Each year management makes minor enhancements to the process employed to calculate historical loss migration and to evaluate collateral in the case of specifically identified credits.

Management continues to monitor the allocation and make necessary adjustments based on portfolio concentration levels, actual loss experience, the financial condition of the borrowers and the economy. For more detailed information related to the calculation of the allowance for loan losses, see Note 1 to the financial statements.

Another factor considered in the assessment of the adequacy of the allowance is the quality of the loan portfolio from a past due standpoint. From year-end 2015 to December 31, 2016, the recorded investment in accruing past due and non-accrual loans decreased by $412,000. This was evidenced by a $652,000 increase in the recorded investment in accruing past due loans and a decrease of $1.1 million in the recorded investment in non-accrual loans during the twelve months of 2016.

The recorded investment of accruing loans past due 30-59 days was $472,000 at December 31, 2016; a $21,000 increase since December 31, 2015. There were seven loans past due 30-59 days at December 31, 2016. Six of the loans were paid current by January (2017). One loan for $36,000 was fully repaid in March (2017).

The recorded investment of loans past due 60-89 days still accruing interest was $737,000 at December 31, 2016. The recorded investment of loans in this delinquency category at December 31, 2015 was $106,000. Three loans are responsible for the balance. One loan comprising 75% of the total in this delinquency category at December 31, 2016, became a troubled debt restructuring when it was granted a payment modification. The Bank is actively trying to assist the borrowers as the underlying cash available for repayment is very seasonal. It is too early to tell if the borrowers will benefit enough from reduced payment obligations to continue operations. In the event the loan does not recover, 75% of the principal is guaranteed by the SBA. One loan with a recorded investment of $144,000 was placed on non-accrual in January (2017) and the Bank is pursuing the associated collateral. There is no loss expected as a result.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

There were no loans still accruing interest past due 90 days and greater at either December 31, 2016 or year-end 2015.

Although the Bank’s total delinquent loans still accruing interest increased since 2015, Management does not feel that the increase is out of line with reasonable, periodic fluctuations and the credit review process continues to be stringent in its oversight.

The recorded investment of non-accrual loans was $123,000 at December 31, 2016 down from $1.2 million at year-end 2015. The reduction since year-end 2015 was primarily concentrated in three relationships and four corresponding loans. Two loans were remediated and returned to an accruing status and two loans were charged-off and the real estate collateral was moved to foreclosed assets and later sold for a gain of $21,000. There were three non-accrual notes remaining at December 31, 2016. Two of the three carried specific allocations. These same two loans were also delinquent in their arranged payments.

Net charge-offs for 2016 were $60,000. This outcome is less than 2015 when the Bank had net charge-offs of $307,000. The ratio of net charge-offs to average loans was 0.05% for 2016; the ratio of net charge-offs to average loans was 0.24% for 2015.

Foreclosed assets decreased by a net figure of $751,000 during 2016. At December 31, 2016, foreclosed assets were $1.5 million. These assets consist of relinquished properties through the collection process which were previously customer collateral supporting various borrowings. These properties are held until they can be sold. The net reduction since year-end 2015 was made up of both additions and sales. Three properties were added, increasing the total of foreclosed assets by $89,000 and ten properties and seven lots were sold for $793,000. There were net gains on these sales of $144,000 recorded in 2016.

Each quarter, foreclosed assets that are determined to have declined in fair value based on a professional appraisal or other common means of valuation are written down. As real estate values stabilize, valuation adjustments have decreased. In aggregate, the inventory of held properties was written down by $190,000 during 2016; $4,000 less than the prior year. At December 31, 2016, there were 14 real estate holdings in foreclosed assets compared to 21 at December 31, 2015.

Some of the foreclosed assets have been held by the Bank for a long time. Management is comfortable with holding these assets at professionally determined fair values rather than forcing liquidation by discounting the properties far below market value less costs to sell. Nonetheless, management objectively evaluates each property quarterly and considers marketability, future costs associated with maintenance along with the selling environment, local economic factors and specific features or characteristics of a property. In some cases, management may agree to accept a sales price that is less than the current valuation which will result in a loss.

Deposit balances were $167.7 million at December 31, 2016; up $6.5 million over December 31, 2015 when deposit balances were $161.2 million. Both non-interest and interest bearing checking rose as well as savings account balances. Conversely, money market and certificates of deposits account balances fell.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

Non-interest bearing checking accounts climbed $7.7 million during 2016 and were $46.9 million at December 31, 2016. This deposit type accounted for 28% of the Bank’s total deposit base at year-end 2016. A majority of the year-over-year increase stemmed from existing customers however, 28% of the growth was derived from new deposit relationships. Funding interest earning assets with non-interest bearing liabilities is very favorable for future earnings.

Interest-bearing checking accounts were $40.8 million on December 31, 2016. Since year-end 2015, interest-bearing checking accounts went up by $4.2 million. Over one third of the increase came from two additional deposits with the rest coming from existing customers.

Savings deposits were $32.7 million at December 31, 2016 compared to $24.4 million at December 31, 2015. There were many new accounts added in 2016 however, over 40% of the increase came from existing public fund customers.

The biggest change in the Bank’s deposit composition was a decrease in time deposits during 2016. Time deposits were $25.6 million at December 31, 2016. During 2016, the Bank’s time deposit portfolio decreased $13.2 million. The maturities were predominantly internet time deposits. As in previous years, the Bank used excess liquidity to fund the maturities. Internet time deposits are non-local time deposits that are solicited through an online marketplace. The Bank’s internet time deposit portfolio was $4.0 million at year-end 2016. During 2017, $3.7 million of this total is scheduled to mature.

Non-deposit funding sources for the Bank, at December 31, 2016, included customer repurchase agreements, FHLB line of credit and advances, Discount Window borrowings and lines of credit from correspondent banks. Typically, unexpected fluctuations in the Bank’s daily liquidity position beyond the amount available in the Bank’s FRB account drive borrowings from these resources. The only source with an outstanding balance at year-end 2016 or 2015 was customer repurchase agreements, which totaled $4.6 million at year-end 2016 compared to a balance of $4.9 million at the end of 2015. The FHLB line of credit was used once during 2016. During 2016, there was no utilization of the Discount Window or the Bank’s overnight fed funds lines with correspondent banks.

Some of the Bank’s non-deposit funding sources require a pledge of assets to collateralize potential borrowings. At December 31, 2016, Bank assets pledged to the FHLB consisted of residential mortgage loans with a book value of $7.2 million and providing the Bank with the ability to borrow approximately $5.5 million; $2.0 million of this total is for the approved line of credit.

Bank assets pledged to the Discount Window consisted of qualifying home equity loans that totaled $1.8 million.

During 2016, the Bank obtained $9 million of overnight federal fund lines from two of its correspondent banks. Neither required a pledge of collateral.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

Subordinated debentures outstanding at December 31, 2015 and 2016 remained at $4.5 million. On December 17, 2004, the Trust, a business trust subsidiary of the Company, using the proceeds from the sale of 4,500 Cumulative Preferred Securities (“trust preferred securities”) at $1,000 per security, purchased an equivalent amount ($4.5 million) of subordinated debentures from the Company. Similar to the rate on the trust preferred securities, the subordinated debentures carry a floating rate of 2.05% over the 3-month LIBOR and was initially set at 4.55%. The current rate of interest is 3.05%. The stated maturity is December 30, 2034. Interest payments on the subordinated debentures are due quarterly on March 30^th, June 30^th, September 30^th and December 30^th.

Under applicable Federal Reserve Board guidelines, the trust preferred securities constitute a restricted core capital element. The guidelines provide that the aggregate amount of restricted core elements that may be included in Tier 1 capital must not exceed 25% of the sum of all core capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability. Any remaining amount is treated as Tier 2 capital for risk-based capital purposes. Additionally, Tier 2 capital cannot exceed Tier 1 capital.

At December 31, 2016, $4.1 million of trust preferred securities were treated as Tier 1 capital and the remaining $400,000 was treated as Tier 2 capital. This is more than at December 31, 2015, when $2.0 million of trust preferred securities were treated as Tier 1 capital and the remaining $2.5 million was treated as Tier 2 capital.

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 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 on March 28, 2016 in tandem with the extinguishment of the Company’s note payable.

Accrued interest expenses and other liabilities decreased $664,000 since year-end 2015. The decrease is mainly attributable to the Company’s repayment of deferred and overdue interest on its subordinated debentures. The amount of deferred and overdue interest was $687,000 at December 31, 2015. 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. The payment on March 30, 2016 cured the interest payment default.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

Recognizing the importance of preserving the Company’s cash for potential capital support for the Bank’s growth, on April 27, 2016, the Company’s Board of Directors voted to again defer interest payments on its subordinated debentures. The deferral of interest does not constitute an event of default. 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. As such, it is expected that the accrued interest balance will increase during the deferral period. The accrued and unpaid interest was $99,000 at December 31, 2016.

During the deferral period, the indenture under which the subordinated debentures were issued prohibits certain actions by the Company. Among other things, and subject to certain exceptions, the Company is prohibited from declaring or paying any dividends or distributions on, or redeeming, purchasing, acquiring or making any liquidation payment with respect to, any shares of its capital stock. Additionally, during the deferral period, interest will continue to accrue on the subordinated debentures and also, the deferred interest will accrue interest.

Shareholders’ equity was $14.1 million on December 31, 2016 compared to $7.6 million on December 31, 2015. The net increase of $6.5 million was made up of $6.3 million of new capital from common stock transactions, earnings of $163,000 and accumulated other comprehensive income (security market value adjustments) of $6,000.

The $6.3 million of additional capital stemmed from the Rights Offering and a series of related transactions. 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 Common Stock at $2.55 per share 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 December 31, 2016 were 4,101,664 compared to 1,468,800 at December 31, 2015. The book value per share was $3.43 at December 31, 2016 compared to $5.15 at December 31, 2015.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

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. Although the Bank continues to be well capitalized, the Company made an additional capital contribution of $125,000 in the third quarter of 2016 to maintain its well-capitalized regulatory capital status. At December 31, 2016, the Bank’s total risk-based capital ratio was 11.12% and its Tier 1 to average assets ratio was 8.30% compared to 9.46% and 6.12%, respectively, at December 31, 2015.

RESULTS OF OPERATIONS

The Company had consolidated earnings of $163,000 for 2016 compared to a consolidated loss of $440,000 for 2015. The Company’s diluted earnings per share were $0.05 for 2016. In 2015, the Company’s diluted loss per share was $0.30. The loss was attributable to two large financial transactions: the recognition of a derivative liability through interest expense and a payment to a third party for the renegotiation of the Bank’s data processing contract. The Company’s accumulated deficit was $5.5 million at December 31, 2016 compared to an accumulated deficit of $5.7 million at December 31, 2015.

The three operating ratios shown below for the years ended December 31, 2016 and 2015 represent the consolidated earnings (losses for 2015) as a proportion of average assets and equity:

	2016			2015

Return (loss) on average assets		0.09	%		(0.24	)%
Return (loss) on average shareholders’ equity		1.30			(5.50	)
Average equity to average assets		6.85			4.29

In 2016, earnings from operations improved, including net interest income. Consequently, most of the improvement to net interest income is due to the recognition of a derivative liability through interest expense in 2015.

For 2016, net interest income was $5.9 million compared to $5.5 million for 2015. The change represents a 7% increase compared to 2015’s results. The increase in net interest income was $403,000. The derivative liability recognized through earnings expense was $427,000. Ignoring the effect of the derivative liability, there was only a $24,000 difference between the two years. The Company continues to focus on improving its mix of earnings assets as well as improve its cost of funds recognizing that these will have a meaningful impact on profitability and net interest margin results going forward, particularly in a rising rate environment.

To make improvements to the mix of interest earning assets, the Company focuses its efforts on reducing its liquidity and growing its loan portfolio. During 2016, loans represented 77% of the Company’s earning assets compared to 75% in 2015. Loan growth needs to be comprehensively monitored in an attempt to mitigate interest rate risk. The two methods used by the Company are balancing rate sensitivity of the portfolio and avoiding extension risk. At December 31, 2016, there were 64% of the loan balances carrying a fixed rate and 36% a floating rate compared to 65% of the loan balances carrying a fixed rate and 35% a floating rate at year-end 2015. Shifts in the rate sensitivity of the loan portfolio are typically the result of the types of loans that were originated or paid off during the year and shifts in customer preference at the time a loan is renewed. Since the rate environment is leaning toward further rate increases, management believes it is beneficial for the Bank to continue increasing its concentration of floating rate loans.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

In the past two years the Bank had been able to reduce its concentration of fixed rate loans by 5%; 1% of the reduction occurred in 2016. Conversely, from 2007-2014, the concentration climbed annually. Achieving and maintaining a more equitable balance between fixed and floating rate loans is management’s goal as it is useful for protecting net interest income during upward or downward movements in rates. Unfortunately, the depth and duration of the low rate environment had a strong impact on the concentration of the Bank’s fixed rate loans. Bank lending personnel will continue efforts to decrease the concentration of fixed rate loans within the loan portfolio but not likely at the expense of quality loan origination, particularly for existing customers.

Avoidance of extension risk is another important means to mitigate interest rate risk. In periods of low interest rates, it is generally not advantageous for a financial institution to book long-term, fixed rate notes like 15 or 30 year residential mortgage loans. For most of its operating years, the Bank has sold 75-90% of the residential mortgage loans it has originated. In spite of a year-over-year increase in the residential segment since year-end 2015, the concentration of residential mortgage loans decreased to 13% of the total loan portfolio; one percent less than at year-end 2015. Similarly, the maturity distribution of the loan portfolio was impacted by a larger number of loan originations. Loans repricing after five years decreased one percent. At year-end 2016, 27% of the Bank’s portfolio has a maturity longer than five years.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

The contractual loan maturities and rate sensitivity of loan portfolio segments at December 31, 2016 are included below:

	Within		Three to		One to		After
	Three		Twelve		Five		Five
	Months		Months		Years		Years		Total

Commercial	$	5,327,382	$	15,341,393	$	21,409,800	$	8,710,600	$	50,789,175
Commercial Real Estate:
General		4,270,311		12,659,427		31,232,750		7,250,213		55,412,701
Construction		2,127,979		1,701,420		2,717,270		1,836,366		8,383,035
Consumer:
Lines of credit		444,377		231,067		2,329,249		2,960,651		5,965,344
Other		41,503		65,888		759,729		302,245		1,169,365
Credit card		51,408		158,553		240,959		0		450,920
Residential		673,625		985,388		0		16,995,031		18,654,044
	$	12,936,585	$	31,143,136	$	58,689,757	$	38,055,106	$	140,824,584
Loans at fixed rates	$	5,398,320	$	12,764,517	$	45,776,050	$	25,499,542	$	89,438,429
Loans at variable rates		7,538,265		18,378,619		12,913,707		12,555,564		51,386,155
	$	12,936,585	$	31,143,136	$	58,689,757	$	38,055,106	$	140,824,584

The maturity distribution of the Bank’s loan portfolio remained relatively balanced between short-term (less than one year) and long-term (greater than five years) maturities at year-end 2016. Short-term maturities comprised 31% of the portfolio and long term maturities comprised approximately 27% of the loan portfolio. Similar to prior years, over 40% of the portfolio carried a maturity between one and five years at December 31, 2016.

As mentioned previously, the loan portfolio comprised 77% of total earning assets at year-end 2016. The securities portfolio was the next largest category and was 13% of earning assets at the same period end; falling 4% in 2016. The Bank did not replace any of its maturing securities during the year. With a reduction of pledging obligations, the Bank chose to use the proceeds to originate loans. Conversely, the concentration of interest-bearing deposits at other financial institutions as a percentage of earning assets rose to ten percent. This increase occurred from growth in deposits. Along with the rate sensitivity and the term considerations, management will continue its efforts to improve the mix of earning assets.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

To illustrate the Company’s net interest income position, 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 period indicated on a tax equivalent basis (a tax rate of 34% was utilized). Such yields and costs are derived by dividing income or expenses by the average daily balance of assets or liabilities, respectively, for the periods presented:

	Years Ended December 31:
	2016							2015
	Average				Average			Average					Average
	Balance		Interest		Yield/Rate			Balance		Interest			Yield/Rate
Assets
Federal funds sold and interest-bearing deposits with banks	$	16,710,873	$	85,877		0.51	%	$	13,872,260	$	35,535			0.26	%
Securities		21,576,893		287,787		1.33			28,283,472		401,107			1.42
Loans ¹		128,312,375		6,335,165		4.94			126,310,490		6,450,119			5.11
Total interest earning assets		166,600,141		6,708,829		4.03			168,466,222		6,886,761			4.09
Other assets		16,952,290							17,795,141
	$	183,552,431						$	186,261,363
Liabilities and Shareholders’ Equity
Interest-bearing deposits	$	121,781,498	$	618,923		0.51	%	$	129,635,242	$	680,235			0.52	%
Repurchase agreements		4,284,173		17,615		0.41			5,546,657		24,406			0.44
Subordinated debentures, notes payable and FHLB advances		4,804,262		158,679		3.30			5,780,000		655,300	²		11.34	²
Total interest bearing liabilities		130,869,933		795,217		0.61			140,961,899		1,359,941			0.96
Noninterest-bearing deposits		39,450,947							36,095,318
Other liabilities		666,842							1,208,556
Shareholders’ Equity		12,564,709							7,995,590
	$	183,552,431						$	186,261,363
Net interest income (tax equivalent basis)				5,913,612							5,526,820
Net interest spread on earning assets (tax equivalent basis)						3.42	%							3.13	%
Net interest margin on earning assets (tax equivalent basis)						3.55								3.28
Average interest-earning assets to average interest-bearing liabilities						127.30								119.51
Tax equivalent adjustment				732							17,184
Net interest income			$	5,912,880						$	5,509,636

¹ Includes loans held for sale and non-accrual loans

²Includes derivative recognition of $426,667

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

The lowest earning asset concentration and the lowest yields are the interest-earning deposits held with other financial institutions. In 2016, the average of these deposits increased $2.8 million. The average balance increased due to deposit growth and from proceeds related to maturing securities. Much of the liquidity during the year was used to repay maturing time deposits and fund loans. With fewer internet time deposit maturity obligations in 2017, the Bank will focus on using excess liquidity for funding loans and purchasing securities. Deposits at the FRB are immediately impacted when the fed funds rates are increased. Since late in 2015, the rate on excess deposits at the FRB has increased by 50 basis points.

Average securities outstanding were much lower in 2016 and the average rate earned declined nine basis points, decreasing interest income generated from this category in 2016 by $113,000 when compared to 2015. In spite of the smaller portfolio, the Bank was able to meet its pledging and liquidity policy needs. With over $9 million of securities maturing during 2017, it is likely that the Bank will be required to purchase securities in 2017 to continue to meet its pledging obligations.

Average loans outstanding were $2.0 million more during 2016 and conversely the weighted average rate on the total portfolio decreased 17 basis points. As such, changes to the yield on the loan portfolio translated to a decrease of $115,000 in interest income. As the economy continues to improve and rates increase, we expect that competition among banks for loans will increase. While some institutions may lower rates to compete on price alone, the Bank’s lending area will not compromise credit quality by utilizing risky loan structure and will instead compete on the quality of our service, relationships and connection to the local market.

Overall, interest income decreased by $178,000 between 2016 and 2015. The decline in interest income yielded an average rate on assets of 4.03%; six basis points less than 2015 when the average rate earned on earning assets was 4.09%. Management expects that future growth in interest income will be driven by changing the mix of earning assets to be more heavily concentrated in loans and securities. Management expects this redistribution of earning assets to continue throughout 2017 as the Bank’s liquidity is used to fund loan commitments and pursue loan growth.

Interest-bearing liabilities are made up of deposits, repurchase agreements, FHLB borrowings, notes payable and subordinated debentures. Together these interest-bearing liabilities, on average, decreased $10.1 million during 2016. The average rate paid on these interest-bearing liabilities was 0.61%; a decrease of 35 basis points over 2015. The decrease was mostly attributable to additional interest expense of $427,000 related to the recognition of a derivative liability in 2015. There was no derivative liability recorded in 2016. Excluding the $427,000 related to the derivative liability in 2015, total interest expense in 2016 was $138,000 less than in 2015 and the average rate paid on interest-bearing liabilities was 0.61 basis points. In 2015, average rate paid on interest-bearing liabilities was 0.66%, excluding the additional expense related to the derivative liability.

In both 2015 and 2016, deposits made up 90 percent or more of interest-bearing liabilities. Because of the heavy concentration of deposits, an improvement in the average rate paid on this liability category has a significant influence on the cost of funds. The year-over-year reduction in the blended rate paid on interest-bearing deposits was achieved through an increase in non-interest bearing deposits as well as a reduction in the amount of time deposits outstanding.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

The time deposit portfolio average balance was reduced by $22.0 million in 2016. The associated reduction in interest expense as a result was $161,000. The decrease in the time deposit portfolio was driven by a decrease of $13.2 million in internet time deposits. Management used excess liquidity to fund the maturities. Time deposits represent a much smaller portion of the Bank’s funding as compared to 2015.

Further reductions in average rate paid on deposits are uncertain given that the rate environment is positioned to increase. It is difficult to predict how rising rates will affect non-maturing deposits since rates are mostly driven by local competition. Future benefits to funding costs are unlikely to come from maturing internet time deposits as only $3.7 million is set to mature in 2017.

The Bank’s customer repurchase agreements average balance outstanding was $1.3 million less at year-end 2016 when compared to year-end 2015. The Bank replaced this product in 2015 with a new interest-bearing deposit account and transferred the balances of all but three customers out of repurchase agreements. The repurchase agreements have tiered pricing based on outstanding balance. The average rate paid can fluctuate with the customer balances. As a result of the decrease in average balance for 2016, the average rate paid declined by three basis points.

The average rate paid on the Company’s note payable and subordinated debentures was 3.30%. On March 28, 2016, the Company’s note payable, which carried a rate of 8%, was repaid (See Note 10). The average rate paid on the Company’s notes payable and subordinated debentures in 2015 was 11.34% because it included interest from the derivative liability recognition. Without the additional $427,000 of interest expense, the average rate paid on notes payable and subordinated debentures would have been 3.96%. The decrease of 66 basis points was due to the elimination of the note payable at the end of the first quarter of 2016.

The Company’s net interest spread increased by 29 basis points, from 3.13% in 2015 to 3.42% in 2016. The Company’s net interest margin on earning assets was 3.55% for the 12 months ended December 31, 2016 and 3.28% for the 12 months ended December 31, 2015. Ignoring the $427,000 interest expense, the Company’s 2015 net interest spread would have been 3.43% and the net interest margin would have been 3.53%; very comparable to 2016.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

As a further demonstration of the effect of rates and volume on this outcome, below is a table displaying the change in interest income and interest expense on interest-earning assets and interest-bearing liabilities segregated between change due to volume and change due to rate:

	Year-ended December 31,
	2016 over 2015
	Total			Volume			Rate
Increase (decrease) in interest income
Interest-bearing deposits with banks	$	50,342		$	8,508		$	41,834
Securities		(96,868	)		(89,364	)		(7,504	)
Loans		(114,954	)		101,131			(216,085	)
Net change in interest income		(161,480	)		20,275			(181,755	)

Increase (decrease) in interest expense
Interest-bearing deposits		(61,312	)		(136,582	)		75,270
Repurchase agreements		(6,791	)		(5,272	)		(1,519	)
Subordinated debentures, notes payable and FHLB advances		(496,621	)		(95,541	)		(401,080	)
Net change in interest expense		(564,724	)		(237,395	)		(327,329	)
Net change in net interest income	$	403,244		$	257,670		$	145,574

As shown above, the decreases to interest income resulted mainly from differences within the loan and securities portfolios. The securities portfolio averaged $6.7 million less between 2016 and 2015. The volume decrease of these earning assets explained over 90% of the decline in interest income in 2016. Interest income on loans declined $115,000 between 2016 and 2015. The change is related to both rate and volume. As discussed above, the average rate earned on the loan portfolio declined 17 basis points in 2016. The lower rates stemmed from both existing loans and new volume. The lower rates resulted in a $216,000 decrease in interest income. Nearly half of this decline was offset by higher volume of loans outstanding between the two years. The average loan portfolio was $2.0 million more in 2016. The additional volume increased interest by $101,000 in 2016.

The decrease to interest expense was largely attributable to the interest expense in 2015 related to the derivative liability recognition but there was also a noticeable decrease related to fewer time deposits. The total interest expense decrease related to volume on interest bearing deposits was $137,000; interest expenses on time deposits decreased by $161,000. With only $3.7 million of internet time deposits slated to mature in 2017, the Bank does not expect a significant decrease in interest expense from fewer time deposits. In general, Management expects the Company’s net interest margin will be challenged in 2017 because of the rising rate environment, coupled with heavy competition on both the deposit and loan side.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

There was no provision for loan losses for either 2015 or 2016. The provision expense is associated with changes in historical loss calculations, economic condition (local and national) as well as delinquency, charge-offs and changes to credit quality grades; up and down. A methodical assessment of these factors generates the reserves required for the risk in the Bank’s loan portfolio and the required provision expense. The process is intended to assess the level of allowance for loan losses which appropriately reflects the risk in the loan portfolio. Management used the same process for monitoring credit quality, delinquency and impaired loans for both 2015 and 2016. 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 depending on loan portfolio growth and incurred losses.

Although the methodology for calculating the allowance and the required provision for loan losses is considered by management to be consistent and reasonable, the allowance level and required provision are estimates. The provision may be increased or decreased in the future to achieve an adequate balance in the allowance.

Non-interest income recorded in 2016 was $1.6 million compared to $1.7 million in 2015, with only a $79,000 difference between the two fiscal years.

Service charges were $450,000 in 2016 and were $117,000 less than 2015. Basic service charges on customer accounts were $13,000 less in 2016 and overdraft fees were down year-over-year. Customer overdraft fees were $411,000 in 2015, but were $306,000 in 2016. Although the fee associated with this transaction remained the same between 2015 and 2016, there were fewer customer overdrafts during 2016.

Recorded gains on loan sales increased in 2016. In 2016, this revenue was $189,000 compared to $123,000 in 2015. In February (2016), Management added an additional mortgage lender who focused on the Grand Haven and Spring Lake market areas. The Bank is projecting a further increase in income from the sales of residential mortgage loans in 2017.

Once again the Bank had net gains on the sale of foreclosed properties but less than in 2015. In 2016, net gains were $144,000. In 2015, net gains were $197,000. Reducing the Bank’s inventory of foreclosed properties will continue to be a priority for the Bank. A majority of the gains were on lot sales in a development that had been heavily impaired during the credit crisis. The book value of this development, after the impairment charge, was such that the entire carrying value was recouped after selling 22 of the original 49 lots. The development now has no carrying value so the sale of each remaining lot results in a gain equal to the sales price. The Bank sold four lots from this development in 2016 compared to eight lots in 2015. There were two lots remaining at year-end 2016.

Other non-interest income was $798,000 in 2016; $26,000 more than $772,000 for 2015. A large portion, 69%, of the increase was from the FHLB. The FHLB rewards its member banks for selling high credit, quality mortgages to them. Essentially, if the sold loans repay as agreed, the FHLB will give the Bank dollars that were originally set aside at the time of sale for potential loss. If the funds are not needed to cover non-performance, it is returned to the sellers. In 2016, the Bank received $18,000. Income from this source is not assured in future years.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

Non-interest expenses decreased $584,000 for the 12 month period ended December 31, 2016 compared to the similar period in 2015. Total non-interest expenses were $7.3 million for 2016. While there were significant decreases recorded in data processing and FDIC insurance expenses, a large portion of the decline was attributable to a decrease of $293,000 in professional services expense.

Data processing expenses were $499,000 in 2016; $94,000 less than 2015. In the third quarter of 2015, the Bank began realizing the benefit of lower data processing costs stemming from a renegotiated contract with its core data processor. The lowered fee schedule has 60 months remaining.

Professional services expenses were $380,000 for 2016 compared to $673,000 in 2015. The $293,000 decrease was largely due to a fee paid to a third party to renegotiate the Bank’s data processing contract in 2015. The $319,000 fee for performing this service was based on the imputed savings over the new contract’s 72 month life.

Foreclosed asset impairment charges of $190,000 in 2016 were recorded; a total that was comparable to $194,000 in 2015. During the time that foreclosed real properties are waiting to be sold, there will be occasions that the Bank will need to reevaluate the individual market values of each property. If there is evidence that the fair value has declined since the last evaluation, the Bank will incur an impairment charge in order to properly reflect the fair value of the asset at the end of the reporting period. Local property values seem to be stable but there are occasions when an impairment will be taken to stimulate sales activity. There were ten properties and seven lots sold in 2016. Some of the Bank’s oldest were among them. At December 31, 2016, the Company held 14 properties in foreclosed assets totaling $1.5 million.

FDIC insurance expenses were $215,000 for 2016 and $391,000 for 2015. The $176,000 reduction in the Bank’s FDIC premium accruals was due to a strengthened regulatory capital position and improved risk profile as well as a change in the FDIC’s assessment process. The FDIC assessment calculation changed on June 30, 2016 because the Deposit Insurance Fund Reserve Ratio rose to a target level triggering the FDIC to make structural changes to deposit insurance assessments. The changes involved creating three tiers of assessment rates; one for newly established banks; one for banks up to $10 billion in consolidated assets and one for banks over $10 billion in consolidated assets. The revised rates for small banks equated to lower premium assessments for the second half of 2016.

Other non-interest expenses were $969,000 for the twelve month period of 2016; $67,000 less than 2015. The improvement was led by a $38,000 decline in expenses to administer impaired assets. In 2016, these expenses totaled $189,000 compared to $227,000 in 2015. Additionally, the premiums on Company’s main commercial insurance policy were reduced by $27,000 in 2016.

The Company recorded a federal income tax expense of $79,000 in 2016 and a federal income tax benefit of $227,000 in 2015.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

LIQUIDITY AND INTEREST RATE SENSITIVITY

The Company’s Asset Liability Committee (“ALCO”), which includes Senior Management, the Bank’s Controller, and Assistant Controller, monitors and manages liquidity and interest rate risk. ALCO reports to the Board of Directors and operates within Board approved policy limits.

Liquidity risk is the risk that the Bank will not meet the cash flow requirements of the Bank’s customers. Liquidity management ensures that funding is available for customer activity, particularly borrowing and withdrawing funds.

In addition to normal loan funding and deposit flow, liquidity management involves planning for sufficient liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit. At December 31, 2016, the Bank had a total of $28.4 million in unfunded loan commitments and $450,000 in unfunded standby letters of credit. Of the total unfunded loan commitments, nearly all were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary. Based on historical usage of lines of credit, the Bank can determine short term exposures to liquidity. The Bank monitors fluctuations in credit line balances and commitment levels, calculates potential exposures to liquidity and includes such data in a liquidity snapshot that is distributed monthly to members of ALCO and the Board of Directors.

A successful liquidity management program provides a variety of resources to utilize to fund Bank operations. The Bank’s main sources of liquidity in times of unexpected customer activity are its excess liquidity at the FRB, borrowing capacity at the FHLB, overnight federal fund lines with correspondent banks, its unencumbered securities, the Discount Window and an internet time deposit listing service.

To accommodate the normal liquidity needs of the Bank, the Cash Management Policy requires that excess liquidity at the FRB together with unencumbered securities and the FHLB overdraft line be in a range of 7% to 10% of total assets. The combined total was 10.54% of total assets at year-end 2016. The ratio is higher because of the excess liquidity at the FRB. The Bank’s FRB balance was $16.6 million; much higher than the desirable level. The Bank’s excess liquidity at the FRB will be used to fund loans, purchase securities and repay maturing time deposits.

Based on Board approval, the Bank has the authority to borrow up to $20 million from the FHLB. At December 31, 2016, the Bank had the capacity to borrow $5.5 million from the FHLB based on a pledge of residential mortgage loans with a book value of $7.2 million and a fair market value of $5.5 million. The Bank’s line of credit uses $2.0 million of the collateral, leaving $3.5 million to borrow in the form of an advance. Another criterion for borrowing from the FHLB is the amount of FHLB stock that a financial institution owns. Based on the Bank’s stock ownership, it has the ability to borrow $4.5 million.

The Bank does not currently have enough collateral pledged to borrow the allowable amount; however, the Bank could either consider pledging some of its unencumbered securities or commercial real estate loans which meet the FHLB’s criteria. FHLB guidelines related to pledging this type of loan are very strict, thus the Bank has not chosen to actively pursue this possibility since there have been only short term borrowing needs that have been covered by the line of credit.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

In 2016, the Bank was upgraded from secondary credit to primary credit at the Discount Window. The upgrade was based on many factors including a stronger regulatory capital position and the termination of its Consent Order with the FDIC in December of 2015. At year-end 2016, the Bank had the ability to borrow $1.8 million from the Discount Window based on a pledge of a like amount of qualifying home equity loans.

The Bank had $1.5 million unencumbered securities at December 31, 2016. This is much less than in past years. The Bank did not replace any of its securities repayments in 2016 due to the reduction in its pledging obligations. The Bank will likely be purchasing additional securities during 2017.

During 2016, the Bank secured two overnight federal funds lines with correspondent banks. The total of these lines is $9 million. This resource would only be used for very temporary liquidity situations.

When longer term liquidity is needed quickly, growing local deposits may not be preferable due to the slower gathering process. In these situations, internet deposits are considered a viable, cost effective resource. The Bank has been a member of an internet subscription service since December 2009. The internet subscription service allows the Bank to post rates for various terms within a closed network of pre-screened investors across the country. Deposits gathered this way are generally between $50,000 and $99,000 each; up to a maximum of $250,000. These deposits are not considered brokered. Internet time deposits have been instrumental as an ALCO tool because the Bank is able to add longer term funding at rates that are significantly below those in the local market. ALCO strives to maximize earnings and will make decisions about targeted deposit gathering using these external sources based on many factors including comparative rate data.

Another important responsibility of the ALCO is to monitor interest rate risk. Interest rate risk is the exposure to adverse changes in net interest income due to changes in interest rates. The Company employs a variety of measurement techniques to identify and manage this risk. A sophisticated simulation model is used to analyze net interest income sensitivity. The model incorporates actual cash flows and contractual repricing behavior as well as economic and market-based assumptions provided by Senior Management. ALCO strives to maintain a balance between interest-earning assets and interest-bearing liabilities. Overnight investments, on which rates change daily, and loans tied to internal and Wall Street Journal prime rate, differ considerably from long-term investment securities and fixed rate loans. Time deposits over $250,000 and money market accounts are more interest rate sensitive than regular savings accounts. Comparison of the repricing intervals of interest-earning assets to interest-bearing liabilities is a measure of interest sensitivity gap. When interest rate sensitivity is not well balanced, there could be a detrimental impact on net interest income in rising or falling rate environments.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

Details of the Company’s repricing gap at December 31, 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	$	17,742,525		$	0		$	0	$	0	$	17,742,525
Securities (includes FHLB stock)		1,656,093			7,472,872			6,700,120		237,179		16,066,264
Loans (includes held for sale)		51,473,677			18,955,186			50,122,644		20,401,077		140,952,584
		70,872,295			26,428,058			56,822,764		20,638,256		174,761,373
Interest-bearing liabilities
Savings and checking		95,210,793			0			0		0		95,210,793
Time deposits <$100,000		1,679,838			8,539,602			5,314,885		29,022		15,563,347
Time deposits >$100,000		1,444,092			4,641,301			3,970,614		0		10,056,007
Repurchase agreements and Federal funds purchased		4,639,766			0			0		0		4,639,766
Notes payable and other borrowings		4,500,000			0			0		0		4,500,000
		107,474,489			13,180,903			9,285,499		29,022		129,969,913
Net asset (liability) repricing gap	$	(36,602,194	)	$	13,247,155		$	47,537,265	$	20,609,234	$	44,791,460
Cumulative net asset (liability) repricing gap	$	(36,602,194	)	$	(23,355,039	)	$	24,182,226	$	44,791,460

The interest rate sensitivity table simply illustrates what the Company is contractually able to change in certain time frames. Currently, the Company has a negative 12 month repricing gap which indicates that the Company is liability sensitive in the next 12 month period. This position implies that increases to the national federal funds rate would have more of an impact on interest expense than on interest income during this period if there were a parallel shift in rates. For instance, if the Company’s internal prime rate went up by 25 basis points and every interest-earning asset and interest-bearing liability on the Company’s December 31, 2016 balance sheet, repricing in the next 12 months, adjusted simultaneously by the same 25 basis points, more liabilities would be affected than assets. Management will carefully consider increases to its deposit rates as the economy improves and the FOMC makes changes to the National Federal Funds Rate. However, it is likely that the Company’s net interest spread will narrow should rates move too quickly in the next 12 months. Balancing the repricing and maturity gaps and managing interest rate sensitivity is a priority of management and will likely be challenging as rates begin to rise.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

CAPITAL RESOURCES

Management’s capital raising efforts, commenced in the fourth quarter of 2015 and completed on March 28, 2016, successfully raised net proceeds, after expenses, of approximately $4.770 million for the Company. As described in more detail below, with these proceeds, the Company repaid the deferred and overdue interest on its trust preferred securities totaling approximately $722,000; made a capital contribution to the Bank of approximately $3.47 million; and retained approximately $600,000 for general operations.

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 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 gross proceeds of approximately $3,500,000. Offering expenses related to the Rights Offering were $225,000.

Immediately following the closing of the Rights Offering and private placement, the Company repaid deferred and overdue interest on its subordinated debentures and contributed capital to the Bank to increase the Bank's capital and regulatory capital ratios. After paying the offering costs, there was approximately $900,000 available to pay the Company’s continuing operating expenses or provide capital support for the Bank.

In 2016, the Company, using proceeds from the Rights Offering and private placement of stock, made two capital contributions to the Bank. On March 31, 2016, the Company contributed $3.35 million of equity to the Bank to strengthen its regulatory capital position. On September 30, 2016, the Company contributed an additional $125,000 to maintain its well-capitalized regulatory status.

Both the Company and the Bank are subject to regulatory capital requirements administered by the federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. In general, capital amounts and classifications are subject to qualitative judgments by regulators about components, risk-weighting, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial condition and results of operations of the Bank.

COMMUNITY SHORES BANK CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS

Prompt corrective action regulations provide five classifications, including well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If a bank is not well-capitalized, regulatory approval is required to accept brokered deposits. Subject to limited exceptions, a bank may not make a capital distribution if, after making the distribution, it would be undercapitalized. If a bank is undercapitalized, it is subject to being closely monitored by its principal federal regulator, its asset growth and expansion are restricted, 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.

Since March 31, 2016, after the first capital contribution of $3.35 million, the Bank was considered well-capitalized according to prompt corrective action regulations. The Bank’s total risk-based capital exceeded 11% and its Tier 1 ratio was over 8%. An additional $125,000 of capital was contributed to the Bank on September 30, 2016 to maintain its well-capitalized regulatory status and at December 31, 2016 the Bank’s total risk-based capital ratio was 11.12% and its Tier 1 ratio to average assets was 8.30%. 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%. The Bank was considered adequately capitalized.

The Company had a cash balance of $642,000 at year-end 2016 available for general operations and further capital support for the Bank. On April 27, 2016, the Company’s Board of Directors voted to again defer interest payments on its subordinated debentures to preserve the Company’s cash. The deferral of interest does not constitute an event of default. 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. As such, it is expected that the accrued interest balance will increase during the deferral period. The accrued and unpaid interest was $99,000 at December 31, 2016.

ADOPTION OF NEW ACCOUNTING STANDARDS—See Note 1

NEWLY ISSUED NOT YET EFFECTIVE ACCOUNTING STANDARDS—See Note 1

Tel: 616-774-7000

Fax: 616-776-3680

www.bdo.com

200 Ottawa Avenue NW, Suite 300

Grand Rapids, MI 49503

Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders

Community Shores Bank Corporation

Muskegon, Michigan

We have audited the accompanying consolidated balance sheets of Community Shores Bank Corporation and subsidiaries (Company) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Community Shores Bank Corporation and subsidiaries at December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.

/s/ BDO USA, LLP
Grand Rapids, Michigan
March 30, 2017

BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.

BDO is the brand name for the BDO network and for each of the BDO Member Firms.

COMMUNITY SHORES BANK CORPORATION

CONSOLIDATED BALANCE SHEETS

December 31, 2016 and 2015

	2016			2015
ASSETS
Cash and due from financial institutions	$	3,339,650		$	2,791,553
Interest-bearing deposits in other financial institutions		17,642,525			15,108,399
Cash and cash equivalents		20,982,175			17,899,952
Term deposit		100,000			0
Securities available for sale (at fair value)		15,765,764			25,209,733
Loans held for sale		128,000			0
Loans		140,824,584			122,741,728
Less: Allowance for loan losses		1,611,820			1,671,416
Net loans		139,212,764			121,070,312
Federal Home Loan Bank stock (at cost)		300,500			300,500
Premises and equipment, net		8,486,355			8,820,502
Accrued interest receivable		393,444			369,442
Foreclosed assets		1,460,394			2,211,327
Net deferred tax asset		4,032,675			4,260,165
Other assets		547,638			879,367
Total assets	$	191,409,709		$	181,021,300

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Non-interest-bearing	$	46,893,163		$	39,236,718
Interest-bearing		120,830,147			121,944,921
Total deposits		167,723,310			161,181,639
Repurchase agreements		4,639,766			4,921,023
Note payable		0			1,280,000
Subordinated debentures		4,500,000			4,500,000
Derivative liability		0			426,667
Accrued expenses and other liabilities		485,153			1,149,544
Total liabilities		177,348,229			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 December 31, 2016 and 1,468,800 issued and outstanding at December 31, 2015		19,626,201			13,296,691
Accumulated deficit		(5,542,341	)		(5,705,469	)
Accumulated other comprehensive loss		(22,380	)		(28,795	)
Total shareholders’ equity		14,061,480			7,562,427
Total liabilities and shareholders’ equity	$	191,409,709		$	181,021,300

See accompanying notes to consolidated financial statements.

COMMUNITY SHORES BANK CORPORATION

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

Years ended December 31, 2016 and 2015

	2016		2015
Interest and dividend income
Loans, including fees	$	6,335,165	$	6,450,119
Securities (including FHLB dividends)		287,055		383,923
Federal funds sold and other income		85,877		35,535
Total interest and dividend income		6,708,097		6,869,577
Interest expense
Deposits		618,923		680,235
Repurchase agreements and other short-term debt		17,615		24,406
Federal Home Loan Bank advances and notes payable		158,679		228,633
Derivative valuation adjustment		0		426,667
Total interest expense		795,217		1,359,941
Net Interest Income		5,912,880		5,509,636
Provision for loan losses		0		0
Net Interest Income After Provision for Loan Losses		5,912,880		5,509,636
Non-interest income
Service charges on deposit accounts		449,937		567,361
Gain on sale of loans		188,877		122,735
Gain on sale of foreclosed assets		143,901		196,566
Gain on sale of premises and equipment		0		750
Other		797,844		772,182
Total non-interest income		1,580,559		1,659,594
Non-interest expense
Salaries and employee benefits		3,999,999		3,960,013
Occupancy		616,476		616,876
Furniture and equipment		368,736		348,525
Advertising		12,473		22,271
Data processing		498,507		593,001
Professional services		380,313		672,916
Foreclosed asset impairment		190,378		193,976
FDIC Insurance		214,912		391,300
Other		969,399		1,036,571
Total non-interest expense		7,251,193		7,835,449
Income (loss) Before Federal Income Tax		242,246		(666,219	)
Federal income tax expense (benefit)		79,118		(226,515	)
Net Income (loss)	$	163,128	$	(439,704	)
Basic average shares outstanding		3,475,819		1,468,800
Diluted average shares outstanding		3,476,803		1,468,800
Basic earnings (loss) per share	$	0.05	$	(0.30	)
Diluted earnings (loss) per share	$	0.05	$	(0.30	)

See accompanying notes to consolidated financial statements.

COMMUNITY SHORES BANK CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Years Ended December 31, 2016 and 2015

	2016		2015

Net income (loss)	$	163,128	$	(439,704	)

Other comprehensive income (loss):
Unrealized holding gains (losses) on available for sale securities		9,721		(119,402	)
Net unrealized gain (loss)		9,721		(119,402	)
Tax effect		3,306		(40,596	)
Total other comprehensive income (loss), net of tax		6,415		(78,806	)

Comprehensive income (loss)	$	169,543	$	(518,510	)

See accompanying notes to consolidated financial statements.

COMMUNITY SHORES BANK CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

December 31, 2016 and 2015

								Accumulated
								Other			Total
			Common		Accumulated			Comprehensive			Shareholders’
	Shares		Stock		Deficit			Income (Loss)			Equity
Balance at January 1, 2015		1,468,800		13,296,691		(5,265,765	)		50,011			8,080,937

Net loss						(439,704	)					(439,704	)
Other comprehensive loss									(78,806	)		(78,806	)

Balance at December 31, 2015		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		3,289,904								3,289,904
Proceeds from private placement		579,412		1,477,501								1,477,501
Note payable conversion to common stock, including derivative liability, net of taxes		670,153		1,561,592								1,561,592
Expense related to share-based compensation				513								513
Net income						163,128						163,128
Other comprehensive income									6,415			6,415

Balance at December 31, 2016		4,101,664	$	19,626,201	$	(5,542,341	)	$	(22,380	)	$	14,061,480

See accompanying notes to consolidated financial statements.

COMMUNITY SHORES BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31, 2016 and 2015

	2016			2015
Cash flows from operating activities
Net income (loss)	$	163,128		$	(439,704	)
Adjustments to reconcile net income (loss) to net cash from operating activities:
Depreciation and amortization		363,928			371,461
Net amortization of securities		200,803			275,040
Net realized gain on sale of loans		(188,877	)		(122,735	)
Net realized gain on sale of premises and equipment		0			(750	)
Net realized gain on sale of foreclosed assets		(143,901	)		(196,566	)
Foreclosed asset impairment		190,378			193,976
Originations of loans for sale		(7,550,970	)		(4,780,325	)
Proceeds from loan sales		7,512,847			5,050,960
Deferred income tax expense (benefit)		224,185			(226,515	)
Valuation adjustment on derivative		0			426,667
Share based compensation		513			0
Net change in:
Accrued interest receivable and other assets		162,660			184,417
Accrued expenses and other liabilities		(664,392	)		249,095
Net cash from operating activities		270,302			985,021
Cash flows from investing activities
Purchase of a Term Deposit		(100,000	)		0
Activity in available for sale securities:
Maturities, prepayments and calls		9,252,887			8,079,243
Purchases		0			(1,992,049	)
Loan originations and payments, net		(18,099,337	)		6,389,292
Redemption of Federal Home Loan Bank Stock, net		0			87,900
Additions to premises and equipment		(29,781	)		(110,432	)
Proceeds from the sale of foreclosed assets		760,341			338,854
Net cash from (used in) investing activities		(8,215,890	)		12,792,808
Cash flows used in financing activities
Net change in deposits		6,541,671			(123,801	)
Repayment of note payable		(8	)		0
Net change in repurchase agreements		(281,257	)		(3,689,598	)
Capital-raising activities
Proceeds from rights offering, net of issuance costs		3,289,904			0
Proceeds from private placement		1,477,501			0
Net cash from (used in) financing activities		11,027,811			(3,813,399	)
Net change in cash and cash equivalents		3,082,223			9,964,430
Beginning cash and cash equivalents		17,899,952			7,935,522
Ending cash and cash equivalents	$	20,982,175		$	17,899,952
Supplemental cash flows information:
Cash paid during the period for interest	$	1,389,627		$	1,261,130
Transfers from loans to foreclosed assets		89,019			349,357
Transfers from loans held for sale to loans held for investment		99,000			0
Transfers from foreclosed assets to SBA receivable		0			40,763
Note payable conversion to common stock, including derivative liability and net of taxes		1,561,592			0
Foreclosed asset sales financed by the Bank		33,134			0

See accompanying notes to consolidated financial statements.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of Community Shores Bank Corporation (the “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”), after elimination of significant intercompany transactions and accounts.

NATURE OF OPERATIONS: The Company was incorporated on July 23, 1998 under Michigan law and is a bank holding company owning all of the common stock of the Bank. The Bank began operations on January 18, 1999 and is a Michigan banking corporation with depository accounts insured by the FDIC. The Bank provides a range of commercial and consumer banking services in West Michigan, primarily in Muskegon County, which includes the cities of Muskegon and North Muskegon, and Northern Ottawa County, which includes the cities of Grand Haven and Spring Lake. Those services reflect the Bank’s strategy of serving small to medium-sized businesses, and individual customers in its market area. Services for businesses include traditional business accounts and both commercial and commercial real estate loans. At year-end 2016, the loan portfolio was 36% commercial and 45% commercial real estate. About 4% of total commercial real estate loans were classified as land development. The remaining 14% of the portfolio is more retail oriented and consists of residential real estate and consumer loans. There are no significant concentrations of loans to any one industry or customer, however, the borrowers’ ability to repay their loans is affected by the real estate market and general market conditions in the Bank’s market area. Management centers the Bank’s retail banking strategy on providing traditional banking products and services, automated teller machines, internet banking, telephone banking and electronic bill-paying services to individuals and businesses in the Bank’s market area.

The Mortgage Company was formed on March 1, 2002 by transferring a majority of the Bank’s commercial and residential real estate loans at that date in exchange for 100% of the equity capital of the Mortgage Company. On the day of formation, the Mortgage Company commenced operations and became legally able to originate residential mortgage loans. The Bank services the entire portfolio of loans held by the Mortgage Company pursuant to a servicing agreement.

Berryfield is a limited liability company that was created in October 2010. The entity’s sole purpose is to oversee the development and sale of vacant lots that have been foreclosed on by the Mortgage Company.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The Company filed an election to become a financial holding company pursuant to Title I of the Gramm-Leach-Bliley Act and on September 27, 2002 received regulatory approval. At that time, the Company formed CS Financial Services. Currently the only source of revenue that CS Financial Services receives is referral fee income from a local insurance agency, Lakeshore Employee Benefits. Lakeshore Employee Benefits offers, among other things, employer-sponsored benefit plans. CS Financial Services has the opportunity to earn a referral fee for each sale of employer-sponsored benefits that is transacted by Lakeshore Employee Benefits as a result of a referral made by CS Financial Services. On April 16, 2009, the Company withdrew its election to be a financial holding company. The election was acknowledged by the FRB. The passive income derived from CS Financial Services affiliation with Lakeshore Employee Benefits is unaffected by this change.

Community Shores Capital Trust I, (“the Trust”) was formed in December 2004. The Company owns all of the common securities of this special purpose trust. The Trust is not consolidated because it is a variable interest entity and the Company is not the primary beneficiary. It exists solely to issue capital securities.

USE OF ESTIMATES: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The primary estimates incorporated into the Company’s consolidated financial statements, which are susceptible to change in the near term, include the allowance for loan losses; the fair value of financial instruments, the carrying value of foreclosed assets and the realization of deferred tax assets.

CASH FLOW REPORTING: Cash and cash equivalents includes cash, demand deposits with other financial institutions, short-term investments (securities with daily put provisions) and federal funds sold. Cash flows are reported net for customer loan and deposit transactions, interest-bearing time deposits with other financial institutions and short-term borrowings with maturities of one year or less.

INTEREST-BEARING DEPOSITS IN OTHER FINANCIAL INSTITUTIONS: Interest-bearing deposits in other financial institutions are carried at cost.

SECURITIES: Securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income. Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are expected. Gains and losses on sales are based on the amortized cost of the security sold.

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when the economic conditions warrant such evaluation.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

In assessing OTTI losses, management considers: the length of time and extent that fair value has been less than cost, the financial condition and near term prospects of the issuer, and whether the Company has the intent to sell or is likely to be required to sell the security before its anticipated recovery (see Note 2).

LOANS: 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. Loans held for sale consisted of residential mortgage loans at year-end 2016. Loans held for sale are reported at the lower of cost or fair value, on an aggregated basis. Residential mortgage loans are sold to outside investors with servicing released.

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.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

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 be 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.

ALLOWANCE FOR LOAN LOSSES: 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, general and unallocated 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 2016.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

For the commercial and commercial real estate portfolio segments, the historical loss is tracked by original loan grade. The Bank utilizes a numeric grading system for commercial and commercial real estate loans. Grades are assigned to each commercial and commercial real estate loan by assessing information about the specific borrower’s situation and the estimated collateral values. The description of the loan grade criteria is included in Note 3. In recent periods, with charge-off activity lessening, the calculated historical loss factor assigned to general allocations was considerably reduced.

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

As noted, charge-off activity in each of the loan segments has been lessening which has been reducing the calculated historical loss factors assigned to the general loan allocation for each loan segment. Therefore to maintain an adequate level of reserve, management has established a minimum loss factor unique to each segment. In periods with lower loss factor calculations, the greater of the minimum loss factor or the calculated loss factor will be used.

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.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

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

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

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

The unallocated portion of the allowance for loan losses is an additional reserve for the uncertainty involved in a growing portfolio and expanding customer base.

There was no material change in these operating doctrines during 2016.

SERVICING RIGHTS: Servicing rights are recognized separately when they are acquired through the sales of loans where servicing is retained by the institution. At this time SBA guaranteed loans are the only loans that are sold where servicing is retained. When loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. Under the fair value measurement method used by the Company, earnings are adjusted for the change in fair value and the amount is included with other non-interest income on the income statement. The fair value of servicing rights is subject to fluctuation as a result of pay-off and pay-down, conventional refinancing or changes in the underlying assumptions. Servicing rights were $1,576 at December 31, 2016 and $5,151 at December 31, 2015. The decrease is due to loan repayments and loans refinanced and transferred to portfolio during 2016. At year-end 2016 there was only one servicing asset remaining. In the past, the Company used a third party to obtain its valuation but now that the remaining balance of the Company’s servicing rights is immaterial, the Company chose not to incur the third party cost. The balance of servicing assets will remain at $1,576 until the loan is repaid. If the servicing asset balance and number of loans increases, third party services will again be considered.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

TRANSFERS OF FINANCIAL ASSETS: Transfers of financial assets, which include loan sales, are accounted for as sales when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

FEDERAL HOME LOAN BANK (FHLB) STOCK: The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends received are reported as income.

PREMISES AND EQUIPMENT: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 40 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 7 years.

FORECLOSED ASSETS: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated selling cost when acquired, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value less estimated costs to sell. If fair value declines subsequent to foreclosure, a direct write-down is recorded through non-interest expense. Operating costs after acquisition are expensed.

LONG-LIVED ASSETS: Premises and equipment and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are written down to fair value.

REPURCHASE AGREEMENTS: Substantially all repurchase agreement liabilities represent amounts advanced by various customers. These balances are not deposits and are not covered by federal deposit insurance. Securities are pledged to cover these liabilities.

DERIVATIVE LIABILITY: This liability stems from a beneficial conversion feature embedded in the Company’s note payable to 1030 Norton LLC. The value of the liability is based on repayment of 100% of the principal balance of the Company’s note payable, which totals $1,280,000, in shares of common stock of the Company. The common stock value was set at a conversion price of $1.91 per share, which is equal to 75% of the per share purchase price established by the Board of Directors of the Company in connection with its registered offering of common stock.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

SHARE BASED COMPENSATION: Compensation cost is recognized for stock based compensation awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

INCOME TAXES: Income tax expense is the total of the current year income tax due or refundable and the change in certain deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets, liabilities and net operating loss carry-forwards, computed using enacted tax rates.

Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

The Company is subject to examinations of federal taxing authorities for years after 2012. The Company recognizes interest and/or penalties related to income tax matters in income tax expense, but did not have any amounts accrued for interest and penalties at either December 31, 2016 or 2015.

OFF-BALANCE SHEET FINANCIAL INSTRUMENTS: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Standby letters of credit are considered guarantees and are recorded at fair value.

EARNINGS (LOSS) PER COMMON SHARE: Basic earnings (loss) per common share is net income (loss) divided by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common share include the dilutive effect of additional potential common shares issuable under share based compensation. On December 20, 2016, the Board granted 30,000 shares of restricted stock. The weighted average of the restricted, unvested shares was considered in computing diluted earnings per share. There were no share based compensation awards outstanding at year-end 2015.

COMPREHENSIVE INCOME (LOSS): Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss), net of income taxes. The Company’s other comprehensive income (loss) includes unrealized gains and losses on securities available for sale, which are also recognized as a separate component of shareholders’ equity.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

LOSS CONTINGENCIES: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not currently believe there are such matters outstanding that will have a material effect on the consolidated financial statements.

RESTRICTIONS ON CASH: The Bank was required to have $1,966,000 of cash on hand, or on deposit, with the Federal Reserve Bank to meet regulatory reserve and clearing requirements at year-end 2016 and $1,813,000 at year-end 2015.

DIVIDEND RESTRICTIONS: Holders of the Company's common stock are entitled to receive dividends that the Board of Directors may declare from time to time. The Company may only pay dividends out of funds that are legally available for that purpose. The Company's ability to pay dividends to its shareholders depends primarily on the Bank’s ability to pay dividends to the Company. Dividend payments and extensions of credit to the Company from the Bank are subject to legal and regulatory limitations, generally based on capital levels and current and retained earnings.

The Company shall not declare or pay any dividends without 30 days prior written approval of the FRB.

In addition, under the terms of the subordinated debentures, the Company is precluded from paying dividends on its common stock because the Company exercised its right to defer payments of interest on the subordinated debentures on April 27, 2016. 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. During the deferral period, the indenture under which the subordinated debentures were issued prohibits the Company from declaring or paying any dividends or distributions on, or redeeming, purchasing, acquiring or making any liquidation payment with respect to, any shares of its common stock.

FAIR VALUE OF FINANCIAL INSTRUMENTS: Fair value of financial instruments is estimated using relevant market information and other assumptions, as more fully disclosed in Note 20. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

ADOPTION OF NEW ACCOUNTING STANDARDS:

In November 2015, FASB issued ASU 2015-17, Income Taxes; Balance Sheet Classification of Deferred Taxes. The amendments in this Update are intended to simplify the presentation of deferred income taxes and requires that deferred tax assets and liabilities be classified as non-current in a classified statement of financial position. The amendment is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. The Company does not classify its statement of financial positions so 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 and involves several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or a liability, 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. In the fourth quarter of 2016, there were restricted stock grants made. The associated compensation expense was classified as equity on the Company’s statement of financial position. Prior to the adoption of ASU 2016-09, there were no stock compensation expenses so the adoption of this guidance did not represent a change in accounting procedures.

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 to January 1, 2018. The adoption of this guidance will not have a material impact because the core revenue of the Company, net interest income on financial assets and liabilities, is explicitly excluded from the scope of ASU 2014-09. The Company is currently reviewing the impact on the non-interest income but does not expect a significant effect on the Company’s results of operations.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (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 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 only financial instruments measured at fair value are the Company’s securities which have always been addressed separately in other comprehensive income so this guidance is not expected to have any 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 Company owns all of its branch locations so the impact of this ASU is not expected to have a material impact.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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.

In August 2016, FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the FASB Emerging Issues Task Force). This ASU addresses concerns regarding diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. In particular, this ASU addresses eight specific cash flow issues in an effort to reduce this diversity in practice: (1) debt prepayment or debt extinguishment costs; (2) settlement of zero-coupon bonds; (3) contingent consideration payments made after a business combination; (4) proceeds from the settlement of insurance claims; (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; (6) distributions received from equity method investees; (7) beneficial interests in securitization transactions; and (8) separately identifiable cash flows and application of the predominance principle. The amendments are effective for annual periods beginning after December 15, 2017, and for interim periods within those annual periods. Out of the eight specific cash flow issues addressed by this guidance many are not relevant to the Company’s current operations. As such, the adoption of this guidance is not expected to have a material effect on the Company’s financial position or results of operations.

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

OPERATING SEGMENTS: While Management monitors the revenue streams of the various products and services, the identifiable segments are not material and operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the financial service operations are considered to be aggregated in one reportable segment, banking.

RECLASSIFICATION: Some items in the prior year financial statements were reclassified to conform to the current presentation.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 – SECURITIES AVAILABLE FOR SALE

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

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
2016
US Treasury	$	503,045	$	1,721	$	0		$	504,766
US Government and federal agency		6,469,467		10,657		(147	)		6,479,977
Municipals		0		0		0			0
Mortgage-backed and collateralized mortgage obligations– residential		8,827,160		43,455		(89,594	)		8,781,021
	$	15,799,672	$	55,833	$	(89,741	)	$	15,765,764
2015
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 Bank was holding one municipal security at December 31, 2015. The security had a maturity of May 2018. The security was called in January of 2016. A majority of the year-over-year reduction in securities stemmed mainly from maturities.

No securities were sold in 2016 or 2015.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 – SECURITIES AVAILABLE FOR SALE (Continued)

The amortized cost and fair value of the securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment fees. Below is the schedule of contractual maturities for securities held at December 31, 2016:

	Amortized		Fair
2016	Cost		Value
Due in one year or less	$	5,974,189	$	5,985,165
Due from one to five years		998,323		999,578
Due from five to ten years		0		0
Due in more than ten years		0		0
Mortgage-backed and collateralized mortgage obligations – residential		8,827,160		8,781,021
	$	15,799,672	$	15,765,764

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 December 31, 2016 and 2015:

	Less than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
2016	Value		Losses			Value		Losses			Value		Losses
US Government and federal agency	$	499,633	$	(147	)	$	0	$	0		$	499,633	$	(147	)
Mortgage-backed and collateralized mortgage obligations - residential		5,406,053		(69,170	)		881,617		(20,424	)		6,287,670		(89,594	)
	$	5,905,686	$	(69,317	)	$	881,617	$	(20,424	)	$	6,787,303	$	(89,741	)

	Less than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
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	)

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 – SECURITIES AVAILABLE FOR SALE (Continued)

Other-Than-Temporary-Impairment

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

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI will be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI will be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

At both year-end 2015 and 2016, 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 Ginnie Mae, Fannie Mae and Freddie Mac. Ginnie Mae has the full faith and credit of the US government. Fannie Mae and Freddie Mac are highly rated by the rating agencies and although their debt is not guaranteed by the US government, the US government in 2008, acknowledged its commitment to support their financial health. At December 31, 2016, 17 debt securities had unrealized losses with aggregate depreciation of 1.30% from the amortized cost basis; three of the 17 had an unrealized loss greater than 12 months.

Five of the 17 securities which had an unrealized loss at year-end 2016 are issued by government agencies and 12 are issued by a government-sponsored entity. It is likely that these debt securities will be retained given the fact that they are pledged to various public funds. The reported decline in value is not material and is deemed to be market driven. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2016.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 – SECURITIES AVAILABLE FOR SALE (Continued)

At year-end 2015 and 2016, 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.

Securities pledged at year-end 2016 had a carrying amount of $14,266,378 and were pledged to secure public fund customers and customer repurchase agreements. Pledged securities at year-end 2015 had a carrying amount of $20,201,813.

NOTE 3 - LOANS

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

	2016			2015

Commercial	$	50,869,327		$	48,287,124
Commercial Real Estate:
General		55,412,701			48,327,074
Construction		8,383,035			2,189,127
Consumer:
Lines of credit		5,965,344			5,296,097
Other		1,169,365			1,167,709
Credit card		450,920			473,048
Residential		18,654,044			17,051,151
Net deferred loan fees		(80,152	)		(49,602	)
		140,824,584			122,741,728
Less: Allowance for loan losses		(1,611,820	)		(1,671,416	)
Loans, net	$	139,212,764		$	121,070,312

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 - LOANS (Continued)

The following tables present the activity in the allowance for loan losses for the years ending December 31, 2016 and 2015 by portfolio segment:

				Commercial
December 31, 2016	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		(87,435	)		(21,871	)		(64,294	)		0			0			(173,600	)
Recoveries		50,953			25,710			37,341			0			0			114,004
Provision for loan losses		130,926			23,821			(36,038	)¹		(7,341	)¹		(111,368	)		0
Ending balance	$	617,002		$	459,805		$	259,194		$	203,312		$	72,507		$	1,611,820

				Commercial
December 31, 2015	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			(469,041	)		(36,755	)		0		0		(505,796	)
Recoveries		47,350			33			151,657			0		0		199,040
Provision for loan losses		(25,568	)		52,564			(86,756	)		6,168		53,592		0
Ending balance	$	522,558		$	432,145		$	322,185		$	210,653	$	183,875	$	1,671,416

¹The negative provision in these loan segments resulted from a reductions in specific reserves, which were greater than the loan loss provision required for growth in outstanding principal.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 – 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 December 31, 2016 and 2015:

2016	Commercial		Commercial Real Estate		Consumer		Residential		Unallocated		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment¹	$	268,274	$	20,595	$	80,503	$	62,962	$	0	$	432,334
Collectively evaluated for impairment		348,728		439,210		178,691		140,350		0		1,106,979
Unallocated		0		0		0		0		72,507		72,507
Total ending allowance balance	$	617,002	$	459,805	$	259,194	$	203,312	$	72,507	$	1,611,820

Loans:
Individually evaluated for impairment¹	$	2,294,672	$	6,328,334	$	165,174	$	526,736	$	0	$	9,314,916
Collectively evaluated for impairment		48,666,710		57,560,977		7,448,194		18,176,652		0		131,852,533
Total ending loans balance	$	50,961,382	$	63,889,311	$	7,613,368	$	18,703,388	$	0	$	141,167,449

2015	Commercial		Commercial Real Estate		Consumer		Residential		Unallocated		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment¹	$	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 impairment¹	$	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

¹Loans that are specifically identified.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 – LOANS (Continued)

The following tables present loans individually evaluated for impairment by class of loans as of December 31, 2016 and 2015. The recorded investment includes unpaid principal 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.

			Unpaid				Average		Interest		Cash Basis
	Recorded		Principal		Related		Recorded		Income		Interest
2016	Investment		Balance		Allowance		Investment		Recognized		Recognized
With no related allowance recorded:
Commercial	$	1,334,036	$	1,394,625	$	0	$	1,355,309	$	60,397	$	49,175
Commercial Real Estate:
General		6,270,915		7,349,245		0		5,148,859		191,666		186,453
Construction		0		0		0		0		0		0
Consumer:
Lines of credit		35,868		35,791		0		71,397		5,010		5,010
Other		0		0		0		0		0		0
Credit card		0		0		0		0		0		0
Residential		181,557		214,031		0		297,361		981		490
Subtotal	$	7,822,376	$	8,993,692	$	0	$	6,872,926	$	258,054	$	241,128
With an allowance recorded:
Commercial	$	960,636	$	970,799	$	268,274	$	996,153	$	43,517	$	43,146
Commercial Real Estate:
General		57,419		57,323		20,595		51,826		2,556		2,556
Construction		0		0		0		0		0		0
Consumer:
Lines of credit		108,825		108,217		60,132		153,010		7,904		7,512
Other		20,481		20,372		20,371		17,827		1,437		1,348
Credit card		0		0		0		0		0		0
Residential		345,179		353,232		62,962		314,968		14,314		14,314
Subtotal	$	1,492,540	$	1,509,943	$	432,334	$	1,533,784	$	69,728	$	68,876
Total	$	9,314,916	$	10,503,635	$	432,334	$	8,406,710	$	327,782	$	310,004

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 – LOANS (Continued)

			Unpaid				Average		Interest		Cash Basis
	Recorded		Principal		Related		Recorded		Income		Interest
2015	Investment		Balance		Allowance		Investment		Recognized		Recognized
With no related allowance recorded:
Commercial	$	1,376,371	$	1,435,861	$	0	$	1,399,958	$	43,691	$	43,691
Commercial Real Estate:
General		5,220,711		6,381,061		0		5,441,287		197,049		197,049
Construction		0		0		0		0		0		0
Consumer:
Lines of credit		15,740		15,740		0		37,181		0		0
Other		0		0		0		0		0		0
Credit card		0		0		0		0		0		0
Residential		414,528		446,950		0		310,890		1,707		1,707
Subtotal	$	7,027,350	$	8,279,612	$	0	$	7,189,316	$	242,447	$	242,447
With an allowance recorded:
Commercial	$	950,694	$	957,412	$	198,222	$	517,165	$	25,498	$	21,824
Commercial Real Estate:
General		112,075		148,165		49,855		282,592		0		0
Construction		0		0		0		0		0		0
Consumer:
Lines of credit		277,230		276,275		129,617		276,204		16,298		16,298
Other		16,353		16,338		16,338		13,361		1,314		1,314
Credit card		0		0		0		0		0		0
Residential		314,650		321,821		71,460		347,398		13,029		12,068
Subtotal	$	1,671,002	$	1,720,011	$	465,492	$	1,436,720	$	56,139	$	51,504
Total	$	8,698,352	$	9,999,623	$	465,492	$	8,626,036	$	298,586	$	293,951

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 – 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, 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	$	298,912	$	592,498	$	0	$	891,410	$	50,058,531	$	50,949,941
Commercial Real Estate:
General		100,058		0		0		100,058		55,404,749		55,504,807
Construction		0		0		0		0		8,384,504		8,384,504
Consumer:
Lines of credit		36,652		0		0		36,652		5,951,862		5,988,514
Other		0		0		0		0		1,173,934		1,173,934
Credit card		0		0		0		0		450,920		450,920
Residential		36,621		144,039		0		180,660		18,410,821		18,591,481
Total	$	472,243	$	736,537	$	0	$	1,208,780	$	139,835,321	$	141,044,101

					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	$	11,441	$	11,441
Commercial Real Estate:
General		0		0		0		0		0		0
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		63,049		0		48,858		111,907		0		111,907
Total	$	63,049	$	0	$	48,858	$	111,907	$	11,441	$	123,348

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 – 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

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 – LOANS (Continued)

Troubled Debt Restructurings:

The Company has $9,102,558 at December 31, 2016 of unpaid principal balance to customers whose loan terms have been modified in troubled debt restructurings. There are specific reserves of $413,252 allocated on $1,458,542 of the total; the remainder of the troubled debt restructurings has no reserves allocated to it. These results are similar to 2015. At December 31, 2015, the Company had $7,965,816 of unpaid principal on troubled debt restructurings. There were specific reserves of $401,072 allocated on $1,500,475 of the total with the remainder having no reserves.

During 2015 and 2016, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a stated rate of interest lower than the current market rate for new debt with similar risk; interest only payments on an amortizing note; a reduced payment amount which does not fully cover the interest; financing concessions; or a permanent reduction of the recorded investment in the loan.

In 2016, two modifications involved a stated interest rate below the current market rate for a period ranging from 4 months to 9 months, while three modifications involved interest rate concessions ranging from 10 months to 23 years.

In 2015, two modifications involved a stated interest rate below the current market rate for a period ranging from 22 months to 15 years, while three modifications for 5 months involved interest-only payments on an amortizing note. One modification involved a reduced payment amount for a period of 19 years.

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.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 – LOANS (Continued)

The following table presents loans by class modified as troubled debt restructurings that occurred during the 12 month period ended December 31, 2016:

		Pre-Modification		Post-Modification
		Outstanding Recorded		Outstanding Recorded		Current
2016	Number of Loans	Investment		Investment		Balance
Troubled Debt Restructurings:
Commercial	1	$	15,107	$	15,107	$	15,107
Commercial Real Estate:
General	2		1,459,234		1,447,566		1,446,718
Consumer:
Other	1		11,566		11,566		11,565
Residential	1		83,310		83,882		83,882
Total	5	$	1,569,217	$	1,558,121	$	1,557,272

Five loans were modified during 2016. Two modifications involved a stated interest rate below the current market rate for a period of 7 and 21 years and two others involved a reduced payment for nine months or less. One residential loan was modified resulting in the borrower receiving a reduced payment for six months. This modification is expected to provide payment relief while the borrower markets the home for sale. After the six months, if the home has not sold, the borrower will receive an interest rate below the current market rate until a sale is completed.

In the 12 month period ended December 31, 2016, there were no charge-offs related to the troubled debt restructurings. As of December 31, 2016, an additional $31,417 of specific reserves were established on these troubled debt restructurings.

The following table presents loans by class modified as troubled debt restructurings that occurred during the 12 month period ended December 31, 2015:

		Pre-Modification		Post-Modification
		Outstanding Recorded		Outstanding Recorded		Current
2015	Number of Loans	Investment		Investment		Balance
Troubled Debt Restructurings:
Commercial	4	$	941,413	$	941,081	$	940,476
Commercial Real Estate:
General	1		249,821		249,821		249,821
Residential	1		272,800		272,800		266,784
Total	6	$	1,464,034	$	1,463,702	$	1,457,081

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 – LOANS (Continued)

Six loans were modified during 2015. The modifications for three commercial and one commercial real estate loan involved reduced payments ranging from 5-186 months. The fourth commercial loan and the residential loan involved permanent financing concessions as the borrowers could not obtain financing elsewhere.

In the 12 month period ended December 31, 2015, there were no charge-offs related to the troubled debt restructurings. As of December 31, 2015, an additional $87,368 of specific reserves were established on these troubled debt restructurings.

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

For the 12 month period ended December 31, 2016, there was one troubled debt restructuring on a commercial loan that experienced a payment default within 12 months following the modification. The recorded investment of the loan at the time of default was $18,301.

For the 12 month period ended December 31, 2015, there were no troubled debt restructurings that experienced a payment default within 12 months following the modification.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 – LOANS (Continued)

Credit Quality Indicators:

The Bank utilizes a numeric grading system for commercial and commercial real estate loans to indicate the strength of the credit. At origination, grades are assigned to each commercial and commercial real estate loan by assessing information about the specific borrower’s situation including cash flow analysis and the estimated collateral values. The loan grade is reassessed at each renewal or amendment but any credit may receive a review based on lender identification of changes in the situation or behavior of the borrower. All commercial and commercial real estate loans exceeding $500,000 are formally reviewed at least annually. Once a loan is graded a 5M or greater number, and is over $100,000, the loan grade will be reanalyzed once a quarter. 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.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 – LOANS (Continued)

As of December 31, 2016 and 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
	2016		2015		2016		2015		2016		2015
1	$	1,288,969	$	871,535	$	0	$	0	$	0	$	0
2		0		0		1,577,808		1,698,136		0		0
3		10,420,192		12,001,827		5,738,500		4,599,484		800,501		65,780
4		16,356,758		12,742,910		17,176,904		14,367,694		4,310,495		264,961
5		17,186,851		18,581,320		18,089,577		15,120,148		1,782,945		371,762
5M		2,606,184		1,426,772		3,087,363		3,940,477		0		0
6		1,200,346		798,475		8,159,197		7,472,404		1,490,563		1,490,636
7		1,890,779		1,939,064		1,674,939		333,169		0		0
8		11,303		13,869		519		869,371		0		0
Total	$	50,961,382	$	48,375,772	$	55,504,807	$	48,400,883	$	8,384,504	$	2,193,139

There was a $1.2 million increase in weaker commercial real estate loans, specifically grades 6,7, and 8. The net change was primarily driven by grade changes to two large commercial real estate credits. Neither of the credits carried a specific allocation in the allowance for loan loss at year-end 2016.

The first of the two commercial real estate properties mentioned above was in the 5M risk category at December of 2015 but downgraded to a 7 by year-end 2016. The $1.4 million loan is secured by Class A medical office space. The loan was downgraded in 2016 because of weak cashflow, deficient collateral coverage and delinquent property taxes. In December (2016), the Bank obtained a professional evaluation of the property and the property’s value had improved which provided management with support for an allocation of zero within the allowance for loan losses at year-end 2016. Nonetheless, management has increased its oversight of this credit and will continue to work with the borrower to ensure that the property is well-managed.

The second of the two commercial real estate properties mentioned above was in risk category 8 at December of 2015 but was upgraded to a 6 by year-end 2016. Previous to the upgrade, the loan was on non-accrual. There were several positive developments occurring in 2016 supporting not only a return to accruing status but also a zero allocation within the allowance for loan losses at year-end 2016. During 2016, the borrower secured a new tenant for the building which strengthened the cashflow coverage of the loan. Additionally, the new tenant increased the occupancy rate which in turn positively impacted the appraisal. In spite of these improvements, the loan is being carefully watched by the Bank’s credit administration staff.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 – LOANS (Continued)

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 December 31, 2016 and 2015:

	Residential
	2016		2015
Performing	$	18,176,652	$	16,368,778
Impaired		526,736		729,178
Total	$	18,703,388	$	17,097,956

	Consumer – Lines of credit				Consumer – Other				Consumer – Credit card
	2016		2015		2016		2015		2016		2015
Performing	$	5,843,821	$	5,021,480	$	1,153,453	$	1,156,291	$	450,920	$	473,048
Impaired		144,693		292,970		20,481		16,353		0		0
Total	$	5,988,514	$	5,314,450	$	1,173,934	$	1,172,644	$	450,920	$	473,048

NOTE 4 – FORECLOSED ASSETS

Foreclosed asset activity for the year ended December 31:

	2016			2015
Beginning of year	$	2,211,327		$	2,238,997
Additions		89,019			349,357
Reductions from sales		(649,574	)		(142,288	)
Direct write-downs		(190,378	)		(193,976	)
Transfer to SBA receivable		0			(40,763	)
End of year	$	1,460,394		$	2,211,327

Expenses related to foreclosed assets include:

		2016				2015
Operating expenses, net of rental income		$	80,782			$	158,384

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.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5 - PREMISES AND EQUIPMENT

Period end premises and equipment were as follows at December 31:

	2016		2015
Land & land improvements	$	4,704,624	$	4,703,312
Buildings & building improvements		6,334,070		6,332,060
Furniture, fixtures and equipment		3,231,264		3,314,126
		14,269,958		14,349,498
Less: accumulated depreciation		5,783,603		5,528,996
	$	8,486,355	$	8,820,502

Depreciation expense was $363,928 for 2016 and $371,461 for 2015.

NOTE 6 - DEPOSITS

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

	2016		2015
Non-interest-bearing DDA	$	46,893,163	$	39,236,718
Interest-bearing DDA		40,848,573		36,675,745
Money market		21,637,723		21,992,206
Savings		32,724,497		24,446,559
Certificate of deposit		25,619,354		38,830,411
	$	167,723,310	$	161,181,639

Time deposits of $250,000 or more were $1,387,575 at year-end 2016 and $1,377,420 at year-end 2015.

Scheduled maturities of time deposits, as of December 31, 2016, were as follows:

2017	$	16,304,833
2018		8,356,479
2019		473,193
2020		10,120
2021		445,706
2022		29,023
	$	25,619,354

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 7 – SHORT-TERM BORROWINGS

The Company’s short-term borrowings outstanding consisted entirely of repurchase agreements at year-end 2015 and 2016. The Company utilized its line of credit with the FHLB one time during 2016. Information regarding repurchase agreements and borrowings from the FHLB is summarized below:

	Repurchase			Borrowings
	Agreements			from FHLB
Outstanding at December 31, 2016	$	4,639,766		$	0
Average interest rate at year-end		0.40	%		0	%
Average balance during year		4,283,900			273
Average interest rate during year		0.41	%		0.34	%
Maximum month end balance during year		5,382,709			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 $4,000,396 pledged to repurchase agreements at December 31, 2016 and $5,341,286 pledged at December 31, 2015.

The Bank has the ability to borrow $1.8 million from the Discount Window. At December 31, 2016, collateral pledged for Discount Window borrowings consisted of $1,781,289 in home equity loans. There have been no borrowings from the Discount Window since January 2010.

Fair Market Value of Securities Pledged to Repurchase Agreements	December 31, 2016		December 31, 2015
U.S. Treasury and agency securities	$	454,400	$	458,700
Mortgage-backed securities		2,895,264		4,002,129
Collateralized mortgage obligations		650,732		880,457
Total	$	4,000,396	$	5,341,286

The Company had $2,614,102 of residential mortgage loans pledged to support its $2,000,000 overdraft line of credit with the FHLB at December 31, 2016.

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 value.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8 – FEDERAL HOME LOAN BANK BORROWINGS

The Bank is a member of the FHLB of Indianapolis. Based on its current FHLB stock holdings and collateral, the Bank has the capacity to borrow $3,520,839 at December 31, 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 $7,216,020 pledged at year-end 2016 and $7,511,449 pledged at year-end 2015. During 2016, the Bank used a portion of the loans pledged to the FHLB as collateral for the Bank’s $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 and the Bank had no other borrowings with the FHLB at either December 31, 2016 or 2015.

NOTE 9 – 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 3.05% at December 31, 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.

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 12.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9 – SUBORDINATED DEBENTURES (Continued)

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. As of December 31, 2016, the accrued and unpaid interest owed on the subordinated debentures was $98,892.

NOTE 10 – NOTES PAYABLE

On March 20, 2013, the Company, with approval from the FRB, borrowed $1,280,000 from 1030 Norton LLC, a Michigan limited liability company owned by nine individuals; three directors of the Company, Gary F. Bogner, Robert L. Chandonnet and Bruce J. Essex, one former director and five local businessmen. On the same day, $500,000 of the proceeds was used to settle, in full, a defaulted debt with a financial institution. The remaining proceeds of the senior debt were used for interest carry and general operations. The note bore interest at a fixed rate of 8.00% per annum, payable 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 original note maturity was March 31, 2015, however in the first quarter of 2015, the members of 1030 Norton LLC agreed to extend the note for another two year period at the same terms and the FRB granted the Company permission to extend and continue paying quarterly interest. 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 will convert 100% of the principal balance of its note, which totals $1,280,000, in shares of common stock of the Company at a conversion price of $1.91 per share, which is equal to 75% of the per share purchase price established by the Board of Directors of the Company in connection with its Rights Offering.

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.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11 – 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 10, the derivative liability, net of related deferred tax, was reclassified to shareholder’s equity at conversion on March 28, 2016.

NOTE 12 – 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 net of 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.

NOTE 13 - BENEFIT PLANS

The Company’s 401(k) benefit plan allows employee contributions up to the dollar limit set by law which was $18,000 for 2016 and 2015. The Company may, at its discretion, make a matching contribution. The matching formula is 100% of the first 3% of compensation contributed and 50% of the next 3%. The Company did not make any matching contributions in 2016 or 2015. Upon reinstatement of the matching contribution, the plan will qualify as a Safe Harbor 401(k) Plan.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 14- INCOME TAXES

The consolidated income tax expense (benefit) was as follows:

	2016			2015
Current benefit	$	(145,067	)	$	(2,824	)
Deferred expense (benefit)		224,185			(223,691	)
Tax expense (benefit)	$	79,118		$	(226,515	)

A reconciliation of the difference between federal income tax expense and the amount computed by applying the statutory rate of 34% in 2016 and 2015 is as follows:

	2016			2015
Tax expense (benefit) at statutory rate	$	73,282		$	(220,427	)
Tax-exempt interest income		(474	)		(10,994	)
Other		6,310			4,906
Federal income tax expense (benefit)	$	79,118		$	(226,515	)

Despite the overall consolidated pre-tax income in 2016, there were temporary difference reversals related to foreclosed asset transactions and impaired loans which were recognized during the year. The net result was an increase to the Company’s net operating loss carryforward which grew to $9.3 million at December 31, 2016 from $9.2 million at December 31, 2015. In spite of this occurrence, the net operating loss carryforward is expected to be fully utilized against future taxable income. The Company’s net operating loss carryforward begins expiring in 2030 and continue through 2036.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 14- INCOME TAXES (Continued)

The net deferred tax asset includes the following amounts of deferred tax assets and liabilities as of December 31, 2016 and 2015:

	2016			2015
Deferred tax asset
Allowance for loan losses	$	66,047		$	64,742
Non-accrual loans		779			59,279
Deferred loan costs, net		27,252			18,560
Derivative Valuation Adjustment		0			145,067
Unrealized loss on securities available for sale		11,529			14,834
AMT credit carryforward		85,822			85,822
Accrued Expenses (461h)		19,592			18,251
Foreclosed assets		862,459			989,662
Other		11,002			(16,625	)
Net operating loss carryforward		3,172,378			3,104,264
		4,256,860			4,483,856
Deferred tax liabilities
Depreciation	$	(185,863	)	$	(208,821	)
FHLB Stock Dividends		(6,769	)		(6,769	)
Prepaid expenses		(15,669	)		(18,291	)
Other		(15,884	)		10,190
		(224,185	)		(223,691	)
Net deferred tax asset	$	4,032,675		$	4,260,165

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 and carry-forward losses to future years. In assessing the need for a valuation allowance, we consider all available positive and negative evidence, including taxable income in carry-back years and expected future taxable income.

Core earnings from banking operations in 2016 as well as the outlook for future earnings supported management’s conclusion that no valuation allowance on the Company’s net deferred tax asset was necessary at December 31, 2016.

There were no unrecognized tax benefits at December 31, 2016 or 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 examinations of federal taxing authorities for years after 2012.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 15 – RELATED PARTY TRANSACTIONS

Loans and commitments to principal officers, directors and their affiliates in 2015 and 2016 were as follows:

	2016			2015
Beginning balance	$	4,751,079		$	2,066,577
New loans and line advances		30,343			3,683,834
Repayments		(666,092	)		(999,332	)
Ending balance	$	4,115,330		$	4,751,079

Deposits from principal officers, directors and their affiliates were $15,519,612 at year-end 2016 and $13,962,918 at year-end 2015.

NOTE 16 – SHARE-BASED COMPENSATION

The Company has one share-based compensation plan as described below. Total compensation cost that has been charged against income for that plan was $513 for 2016. There was no compensation cost charged against income for 2015.

Stock Incentive Plan of 2016

Under the Stock Incentive Plan of 2016, incentive awards may include, but are not limited to stock options, restricted stock, restricted stock unit, stock appreciation rights and other stock-related awards. Incentive awards that are stock options or stock appreciation rights are granted with an exercise price not less than the closing price of our common stock on the date of grant. Price, vesting and expiration date parameters are determined by the Board or a committee of the Board on a grant by grant basis. There were 500,000 shares available for incentive awards upon adoption of the plan.

On December 20, 2016, the Board granted 30,000 shares of restricted stock. The restricted stock will vest over five years. At year-end 2016, there were 470,000 shares available for future rewards.

A summary of the restricted stock activity in the plan for 2016 is as follows:

			Weighted Average
	Number of		Grant Date
	Shares		Fair Value
Non-vested at beginning of year		0	$	0
Granted		30,000		2.27
Exercised		0		0
Forfeited		0		0
Non-vested at end of year		30,000	$	2.27

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS

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 of less $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.

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 will 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 December 31, 2016, the capital conservation buffer was 3.12%.

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. Another capital contribution of $125,000 was made on September 30, 2016.

At December 31, 2016, the Bank’s total risk-based capital ratio was 11.12% and its Tier 1 to average assets ratio was 8.30%.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS (Continued)

Included in the tables below are the actual capital amounts and ratios for the Bank and the required capital amounts and ratios for the Bank at both December 31, 2016 and 2015.

											Minimum Required
											to Be Well
						Minimum Required					Capitalized Under
						For Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
2016
Common Equity Tier 1 (CET1) to risk-weighted assets of the Bank	$	14,917,302		10.03	%	$	6,689,791		4.50	%	$	9,663,031		6.50	%
Total Capital (Tier 1 and Tier 2) to risk-weighted assets of the Bank		16,529,122		11.12			11,892,961		8.00			14,866,201		10.00
Tier 1 (Core) Capital to risk-weighted assets of the Bank		14,917,302		10.03			8,919,721		6.00			11,892,961		8.00
Tier 1 (Core) Capital to average assets of the Bank		14,917,302		8.30			7,184,813		4.00			8,981,016		5.00

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS (Continued)

Prior to the capital contribution on March 31, 2016, the Bank had an adequately capitalized regulatory capital classification.

The capital ratios at December 31, 2015 were a total risked based capital ratio of 9.46% and a Tier 1 ratio to average assets of 6.12%.

											Minimum Required
											to Be Well
						Minimum Required					Capitalized Under
						For Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
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

In determining capital for the regulatory ratio calculations, FRB 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 year-end periods of 2015 and 2016, the full balance of the allowance for loan losses was counted as Tier 2 capital and nothing was disallowed. At December 31, 2016 the balance of the allowance for loan losses was $1,611,820 and at December 31, 2015, the balance of the allowance for loan losses was $1,671,416.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 18 – OFF-BALANCE SHEET ACTIVITIES

Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection, are issued to meet customer financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Risk of credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment.

The contractual amount of unfunded financial instruments with off-balance sheet risk was as follows at December 31, 2016 and 2015:

	2016				2015
	Fixed		Variable		Fixed		Variable
	Rate		Rate		Rate		Rate

Unused lines of credit	$	1,912,012	$	25,263,371	$	2,728,791	$	21,803,733
Unused standby letters of credit		0		450,000		0		1,362,000
Commitments to make loans		191,890		1,007,120		157,900		200,000

Commitments to make loans are generally made for periods of 60 days or less.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 19 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION

Following are condensed parent company only financial statements:

CONDENSED BALANCE SHEETS

December 31,

	2016		2015
ASSETS
Cash and cash equivalents	$	642,215	$	41,123
Investment in subsidiaries		17,313,844		13,531,663
Other assets		716,233		951,424

Total assets	$	18,672,292	$	14,524,210

LIABILITIES AND EQUITY
Accrued expenses and other liabilities	$	110,812	$	755,116
Derivative liability		0		426,667
Note payable		0		1,280,000
Subordinated debentures		4,500,000		4,500,000
Shareholders’ equity		14,061,480		7,562,427

Total liabilities and shareholders’ equity	$	18,672,292	$	14,524,210

CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Years Ended December 31,

	2016			2015
Other income	$	1,422		$	435
Interest expense		(158,679	)		(228,633	)
Derivative valuation adjustment		0			(426,667	)
Other expense		(78,191	)		(86,125	)
Loss before income tax benefit and undistributed subsidiary income		(235,448	)		(740,990	)
Equity in undistributed subsidiaries income		318,524			49,349
Federal income tax benefit		(80,052	)		(251,937	)

Net income (loss)		163,128			(439,704	)
Other comprehensive income (loss)		6,415			(78,806	)
Comprehensive income (loss)	$	169,543		$	(518,510	)

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 19 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (Continued)

CONDENSED STATEMENTS OF CASH FLOWS

Years Ended December 31,

	2016			2015
Cash flows used by operating activities
Net income (loss)	$	163,128		$	(439,704	)
Equity in undistributed subsidiaries income		(318,524	)		(49,349	)
Derivative liability		0			426,667
Change in federal tax benefit		219,849			(251,937	)
Share-based compensation expense		513			0
Net change in:
Other assets		(129,725	)		(161,194	)
Other liabilities		(644,304	)		161,236
Net cash used by operating activities		(709,063	)		(314,281	)

Cash flows from (used by) investing activities
Capital investment redeemed from (into) subsidiaries		(3,457,242	)		26,234

Cash flows from financing activities
Repayment of note payable		(8	)		0
Proceeds from rights offering, net of issuance costs		3,289,904			0
Proceeds from private placement		1,477,501			0
Net cash from financing activities		4,767,397			0

Net change in cash and cash equivalents		601,092			(288,047	)
Beginning cash and cash equivalents		41,123			329,170

Ending cash and cash equivalents	$	642,215		$	41,123
Supplemental cash flows information:
Note payable conversion to common stock, including derivative liability and net of taxes	$	1,561,592		$	0

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 20 - FAIR VALUE MEASUREMENTS

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

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

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

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

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

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

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.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 20 - FAIR VALUE MEASUREMENTS (Continued)

Non-real estate collateral may be valued using appraisals, independent valuation tools 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.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 20 - FAIR VALUE MEASUREMENTS (Continued)

Assets measured at fair value on a recurring basis are summarized below for the years ended December 31, 2016 and 2015:

			Fair Value Measurements Using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
December 31, 2016
Available for sale securities:
US Treasury	$	504,766	$	504,766	$	0	$	0
US Government and federal agency		6,479,977		0		6,479,977		0
Mortgage-backed and collateralized mortgage obligations– residential		8,781,021		0		8,781,021		0
Total	$	15,765,764	$	504,766	$	15,260,998	$	0

	Total		(Level 1)		(Level 2)		(Level 3)
December 31, 2015
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

There were no transfers between Level 1 and Level 2 securities during 2016 or 2015.

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 20 - FAIR VALUE MEASUREMENTS (Continued)

Assets measured at fair value on a non-recurring basis are summarized below for the period ended December 31, 2016 and 2015.

			Quoted Prices in		Significant
			Active Markets for		Other Observable		Significant
			Identical Assets		Inputs		Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
December 31, 2016
Impaired loans¹:	$	3,210,340	$	0	$	0	$	3,210,340
Foreclosed assets:		1,460,394		0		0		1,460,394
Total	$	4,670,734	$	0	$	0	$	4,670,734

			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

¹Collateral dependent

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 20 - FAIR VALUE MEASUREMENTS (Continued)

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

	Valuation	Significant Unobservable	Range
	Technique	Inputs	of Inputs
December 31, 2016

Impaired loans	Sales comparison approach	Adjustments for differences between comparable sales	(25)-19	%
	Income approach	Capitalization rate	9-12.5	%

Foreclosed assets	Sales comparison approach	Adjustments for differences between comparable sales	(22)-14	%

	Valuation	Significant Unobservable	Range
	Technique	Inputs	of Inputs
December 31, 2015

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	%

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 20 - FAIR VALUE MEASUREMENTS (Continued)

The carrying amounts and estimated fair values of financial instruments, not previously presented above, were as follows at year-end:

			Fair Value Measurements
			at December 31, 2016 Using
	Carrying
	Amount		Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Cash and cash equivalents	$	21,082	$	20,982	$	100	$	0	$	21,082
Loans held for sale		128		0		131		0		131
Loans, net (including impaired)		139,213		0		0		136,902		136,902
FHLB stock		301		N/A		N/A		N/A		N/A
Accrued interest receivable		393		5		45		343		393

Financial liabilities
Deposits		167,723		0		155,546		0		155,546
Repurchase agreements		4,640		0		4,640		0		4,640
Subordinated debentures		4,500		0		0		4,686		4,686
Notes payable		0		0		0		0		0
Accrued interest payable		119		0		20		99		119

			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		1,125		1,125
Notes payable		1,280		0		0		1,707		1,707
Accrued interest payable		734		0		20		198		218

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 20 - FAIR VALUE MEASUREMENTS (Continued)

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

(a) Cash and cash equivalents

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

(b) FHLB stock

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

(c) Loans

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

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

(d) Deposits

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

(e) Federal funds purchased and repurchase agreements

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

COMMUNITY SHORES BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 20 - FAIR VALUE MEASUREMENTS (Continued)

(f) Subordinated debentures and Notes payable

The fair value of the Company’s subordinated debentures is 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. The fair value of the Company’s notes payable is based upon an expected agreement for settlement of the loan with the creditor resulting in a Level 3 classification.

(g) Accrued interest receivable/payable

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

(h) Off-balance sheet instruments

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

NOTE 21 – SUBSEQUENT EVENT

On March 16, 2017, the FRB publicly announced the termination of its Written Agreement with the Company. The Written Agreement was entered into in December of 2010.

Going forward, the FRB requests that the Company obtain written approval at least 30 days prior to declaring or paying a dividend on any class of its stock; increasing its debt, including the issuance of trust preferred securities; or redeeming any Company stock.

SHAREHOLDER INFORMATION

SEC Form 10-K

Copies of the Company’s annual report on Form 10-K, as filed with the Securities and Exchange Commission, are available to shareholders without charge, upon written request. Please mail your request to Tracey A. Welsh, Senior Vice President and Chief Financial Officer, at Community Shores Bank Corporation, 1030 W. Norton Avenue, Muskegon, Michigan 49441.

Stock Information

The Company’s common stock is traded on the OTC under the ticker symbol "CSHB". At March 22, 2017, there were approximately 163 record holders of the Company’s common stock. The Company has paid no dividends since its formation in 1998.

The following table shows the high and low sales prices for the common stock of the Company by quarter during 2015 and 2016, as reported by the OTC. The Company’s bid prices cannot be calculated due to limited market activity.

Sales Prices

	High		Low
Calendar Year 2016
First Quarter	$	2.45	$	1.85
Second Quarter		2.38		2.10
Third Quarter		2.29		2.17
Fourth Quarter		2.41		2.17

Calendar Year 2015
First Quarter	$	3.24	$	1.50
Second Quarter		3.00		2.21
Third Quarter		3.00		2.30
Fourth Quarter		2.65		2.15

Market Makers

At March 31, 2017 the following firms were registered with OTC as market makers in common stock of the Company:

Boenning & Scattergood, Inc.

4 Tower Bridge

200 Barr Harbor Drive, Suite 300

West Conshohocken, PA 19428

Monroe Financial Partners

100 N. Riverside Plaza

Suite 1620

Chicago, IL 60606

Raymond James & Associates, Inc.

880 Carillon Parkway

St. Petersburg, FL 33716

Stock Registrar and Transfer Agent

Computershare, Inc

Regular Mail Delivery:

Computershare, Inc.

P.O. BOX 30170

College Station, TX 77842

For Overnight Delivery:

Computershare, Inc.

211 Quality Circle Suite 210

College Station, TX 77845

1-800-368-5948, via e-mail at their

website, www.computershare.com

Legal Counsel

Dickinson Wright PLLC

2600 West Big Beaver Road, Suite 300

Troy, Michigan 48084

and

200 Ottawa Avenue, N.W., Suite 1000

Grand Rapids, Michigan 49503

www.dickinsonwright.com

Independent Auditors

BDO USA, LLP

200 Ottawa Avenue N.W., Suite 300

Grand Rapids, Michigan 49503

Additional Information

News media representatives and those seeking additional information about the Company should contact Heather D. Brolick, President and Chief Executive Officer of the Company, at (231) 780-1800, or by writing her at 1030 W. Norton Avenue, Muskegon, Michigan 49441.

Annual Meeting

This year’s Annual Meeting will be held at 9:00 a.m. on Wednesday, May 24, 2017 at the Muskegon Country Club, 2801 Lakeshore Drive, Muskegon, Michigan.

DIRECTORS AND OFFICERS

Community Shores Bank Corporation Board of Directors

Gary F. Bogner		Real Estate Developer
(Chairman, non-officer)

Stanley L. Boelkins		Associate Broker, Capstone Real Estate LLC

Heather D. Brolick		President and Chief Executive Officer

Robert L. Chandonnet		Owner and President, The Nugent Sand Company, Inc.
(Vice Chairman, non-officer)

Bruce J. Essex		Former Chairman, Port City Die Cast

Julie K. Greene		Chief Executive Officer, Muskegon Surgery Center

Executive Officers

Heather D. Brolick		President and Chief Executive Officer

Michael E. Skinner		Senior Vice President / Chief Lending Officer

Tracey A. Welsh		Senior Vice President / Chief Financial Officer, Secretary and Treasurer

DIRECTORS AND OFFICERS

Community Shores Bank Board of Directors

Gary F. Bogner		Real Estate Developer
(Chairman, non-officer)

Stanley L. Boelkins		Associate Broker, Capstone Real Estate LLC

Heather D. Brolick		President and Chief Executive Officer

Robert L. Chandonnet		Owner and President, The Nugent Sand Company, Inc.
(Vice Chairman, non-officer)

Bruce J. Essex		Former Chairman, Port City Die Cast

Julie K. Greene		Chief Executive Officer, Muskegon Surgery Center

Management Team

Heather D. Brolick		President and Chief Executive Officer

Sharon L. Gary		Assistant Vice President / Human Resources Manager

Susan M. Kane		Vice President / Mortgage Origination & Operations Manager

Amy L. Schultz		Senior Vice President and Technology / Operations Manager

Cerise A. Semrinec		Senior Vice President / Credit Administrator

Michael E. Skinner		Senior Vice President / Chief Lending Officer

Lori E. Versalle		Senior Vice President / Branch Administrator

Tracey A. Welsh		Senior Vice President / Chief Financial Officer, Secretary and Treasurer

DIRECTORS AND OFFICERS

Sherri S. Campbell		Vice President / Compliance & Electronic Banking Manager

Brenda S. Carlson		Electronic Banking Operations Specialist Coordinator

Clement E. Coulombe		Assistant Vice President / Controller

Jennifer L. Egeler		Senior Accountant

Jon M. Huizenga		Vice President / Commercial Lending Officer

Christopher J. Knoll		Credit Manager

Alan W. Kowalski		Assistant Vice President / Loan Adjustment - Collections Manager

Christopher M. Kuhn		Vice President / Commercial Lending Officer

Mari K. Larson		Loan Operations Supervisor

Evan P. Luczak		Grand Haven Branch Manager

Ronald A. Mann, Jr.		Vice President / Commercial Lending Officer

Renee L. Nyblade		Vice President / Mortgage Loan Officer

Jennifer K. Pallasch		Senior Accountant

Jamie J. Sheffer		Assistant Vice President / North Muskegon Branch Manager

Laure A. Stovall		Harvey Branch Manager

Tracy L. Straight		Vice President / Mortgage Loan Originator

Clinton A. Todd		Vice President / Retail Lending Officer

Catherine M. VanPelt		Assistant Vice President / Security and Processing Manager

Bretta D. Young		Main Office Branch Manager

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COMMUNITY SHORES BANK CORP Reports