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| CSHB > SEC Filings for CSHB > Form 10-Q on 14-Nov-2008 | All Recent SEC Filings |
14-Nov-2008
Quarterly Report
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussion below details the financial results of the Company and its wholly owned subsidiaries, the Bank and Community Shores Financial Services, and the Bank's subsidiary, the Mortgage Company, through September 30, 2008 and is separated into two parts which are labeled, Financial Condition and Results of Operations. The part labeled Financial Condition compares the financial condition at September 30, 2008 to that at December 31, 2007. The part labeled Results of Operations discusses the three month and nine month periods ended September 30, 2008 as compared to the same periods of 2007. Both parts should be read in conjunction with the interim consolidated financial statements and footnotes included in Item 1 of Part I of this Form 10-Q.
This discussion and analysis and other sections of this Form 10-Q contain forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about the Company, the Bank, the Mortgage Company and Community Shores 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; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; changes in the national and local economy; the ability of the Company to borrow money or raise additional capital 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.
The overall economic environment is more challenging than we have ever seen. Much of the difficulty in the financial market centers on the lack of activity and declining valuations in real estate. The negative effect of this downturn in real estate has adversely affected credit markets and consumer confidence. The government has attempted to address these issues by developing and enhancing various programs.
In an attempt to loosen the credit market, the U.S. Treasury Department has made funds available to certain banks under the Troubled Asset Relief Capital Purchase Program. Management has had preliminary discussions with bank regulators concerning the program and is considering participating.
To build consumer confidence in the safety of deposit accounts, the Federal Deposit Insurance Corporation ("FDIC") broadened deposit protection in two ways. On October 3, 2008, basic insurance coverage was increased from $100,000 to $250,000 per depositor and on October 14, 2008, the FDIC began providing full coverage for non-interest bearing transaction accounts held at participating FDIC insured institutions. Community Shores Bank has chosen to participate in this program. The additional FDIC coverage is scheduled to end on December 31, 2009.
Participation in any of the government programs described above will have an impact on the future earnings of the Company.
FINANCIAL CONDITION
Total assets decreased by $16.6 million to $256.9 million at September 30, 2008 from $273.5 million at December 31, 2007. This is a 6.1% decrease in assets during the first nine months of 2008. Balance sheet changes consisted of loan paydowns, an increase in other real estate owned and decreases in deposits. Since year-end 2007 deposit decreases have been greater than that of loans resulting in a $4.3 million decrease in federal funds sold.
Cash and cash equivalents decreased by $3.7 million to $4.2 million at September 30, 2008 from $7.9 million at December 31, 2007. This change was mostly reflective of decreases in federal funds sold between the above two periods.
The Bank's investment portfolio was $19.0 million at September 30, 2008 compared to $19.8 million at December 31, 2007. There have been very few security transactions in the first nine months of the year. In general, the Bank has a portfolio consisting of municipals, government agencies and some mortgage backed securities. The Company evaluates securities for other-than-temporary impairment on a quarterly basis. No unrealized losses have been recognized into income as a result. At September 30, 2008, fourteen debt securities had unrealized losses with aggregate depreciation of 1.03% from the Company's amortized cost basis. Five of the fourteen securities are issued by government agencies. As the Company has the ability to hold these debt securities until maturity, or for the foreseeable future if classified as available for sale, no declines are deemed to be other-than-temporary.
Total loans (held for investment) decreased $12.5 million and were $217.7 million at September 30, 2008 down from $230.2 million at December 31, 2007. The decrease is evidenced by a decline of $13.4 million in the commercial, commercial real estate, construction and consumer loan portfolios partially offset by a $.9 million net growth in the residential real estate portfolio. During the first nine months of 2008, two customers made large pay downs on lines of credit; a home equity customer paid $1.5 million and a commercial customer paid $2.4 million. One commercial participation note for $2.8 million was bought back by the lead
financial institution. Four commercial real estate notes totaling $6.0 million were refinanced with other financial institutions. There were collected prepayment fees totaling $65,000 on three of the notes. The Bank's underwriting standards include pricing for risk and profitability which does not always result in the lowest market rate. Although the loss of loan volume is unfortunate, management believes that adhering to high underwriting standards will be the most prudent tactic, particularly in this economic environment.
Other lending activity during the first three quarters of 2008 included the origination of $22.5 million of residential mortgage and Small Business Administration ("SBA") loans and the sale of $23.7 million of residential mortgage and SBA loans. The total of loans sold included $1.1 million of residential loans originated in previous years. The associated gain on all loan sales was $320,000. These results compare favorably to originations of $16.4 million, sales of $15.9 million and gains of $239,000 occurring in the first three quarters of 2007.
Presently, the commercial and commercial real estate categories of loans comprise 78% of the Bank's total loan portfolio, the same as year-end 2007. As a result of declining real property valuations and the struggling economy the Bank has chosen to selectively participate in deals that involve these types of loans. Since year-end 2007, the five experienced lenders on staff have focused mainly on the needs of their current customer base. The current tactics in the commercial and commercial real estate areas directly supports the Bank's ongoing strategic objective to diversify its loan portfolio. The diversification plan was initially implemented in the spring of 2007 when several mortgage originators were hired to help increase the Bank's retail presence in it's defined market area utilizing the newly constructed branch facilities. Since March 2007, portfolio retail loans have increased by over $7.9 million with total originations exceeding $51 million. A majority of the loans originated are residential mortgages and are sold in the secondary market. Considering the state of the financial industry, management feels that the Bank's current lending directives are the most prudent to preserve capital in the short term.
Interest rate risk may also impact the Company's capital position. The Company attempts to mitigate interest rate risk in its loan portfolio in many ways. In addition to product diversification, two other methods used are to balance the rate sensitivity of the portfolio and avoid extension risk(1). The loan maturities and rate sensitivity of the loan portfolio at September 30, 2008 are set forth below:
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
----------- ----------- ------------ ----------- ------------
Commercial, financial and other $20,870,213 $30,766,612 $27,995,748 $ 3,032,228 $82,664,801
Real estate:
commercial 12,672,250 13,577,159 58,463,401 1,757,963 86,470,773
construction 1,184,764 2,276,443 26,135 118,295 3,605,637
mortgages 338,531 413,668 2,567,295 13,436,239 16,755,733
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Consumer 2,622,793 3,635,676 17,303,231 4,630,055 28,191,755
----------- ----------- ------------ ----------- ------------
$37,688,551 $50,669,558 $106,355,810 $22,974,780 $217,688,699
=========== =========== ============ =========== ============
Loans at fixed rates 4,145,678 16,087,161 93,908,933 21,226,045 135,367,817
Loans at variable rates 33,542,873 34,582,397 12,446,877 1,748,735 82,320,882
----------- ----------- ------------ ----------- ------------
$37,688,551 $50,669,558 $106,355,810 $22,974,780 $217,688,699
=========== =========== ============ =========== ============
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At September 30, 2008, there were 62% of the loan balances carrying a fixed rate and 38% a floating rate, and only 11% of the entire portfolio had a contractual maturity longer than five years. During 2007 there was an increase in the concentration of fixed rate loans. Some of the shift is a factor of the types of loans added to the portfolio and some is customer preference. The maturity distribution of the loan portfolio has lengthened with the recent concentration on the mortgage business line, however the emphasis remains on loans salable into the secondary market. Management only expects to retain 10-15% of residential mortgages originated because of the longer contractual terms generally involved in mortgage products. Having a larger concentration of fixed rate loans is helpful in a declining rate environment but both types of loans are useful to protect interest income during periods of interest rate fluctuations.
Another risk included as part of the Bank's risk management program, is credit risk estimation. The balance in the allowance for loan losses is based on management's estimation of probable incurred credit losses. The estimation is the result of loan portfolio analysis completed utilizing a detailed methodology prescribed in the Bank's credit policy. The loan portfolio is reviewed and analyzed on a regular basis for the purpose of estimating probable incurred credit losses. The analysis of the allowance for loan losses is comprised of two portions: general credit allocations and specific credit allocations. General credit allocations are made to various categories of loans based on loan ratings, delinquency trends, historical loss experience as well as current economic conditions. The specific credit allocation includes a detailed review of a credit resulting in an allocation being made to the allowance. The allowance for loan losses is adjusted accordingly to maintain an adequate level based on the conclusion of the analysis. There are occasions when an impaired loan requires no allocated allowance for loan losses. To have no allocated allowance for loan loss a specifically identified loan must be well secured and have a collateral analysis that supports a loan loss reserve allocation of zero.
At September 30, 2008 there were $9.8 million in outstanding loans deemed to be impaired but requiring no allocated allowance for loans losses. Poor financial performance in 2007 (evidenced by professionally compiled Federal tax returns) is the biggest reason many credits are deemed impaired. Approximately 90 percent of the increase in impaired loans with no allocated allowance is a result of poor financial performance in the last fiscal year.
During the first nine months of 2008, $479,000 was added to the allowance through the provision expense. At September 30, 2008, the allowance totaled $3.3 million or approximately 1.51% of gross loans outstanding, compared to 1.57% at December 31, 2007.
The allocation of the allowance at September 30, 2008 was as follows:
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
September 30, 2008 December 31, 2007
-------------------------- --------------------------
Percent of Percent of
Allowance Allowance
Related to Related to
Amount Loan Category Amount Loan Category
---------- ------------- ---------- -------------
Balance at End of Period Applicable to:
Commercial $1,670,991 50.9% $1,687,805 46.9%
Real estate:
Commercial 1,136,981 34.6 1,331,132 36.9
Residential 109,177 3.3 129,906 3.6
Construction 47,257 1.4 89,672 2.5
Consumer 320,262 9.8 364,433 10.1
---------- ----- ---------- -----
Total $3,284,668 100.0% $3,602,948 100.0%
========== ===== ========== =====
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Another factor considered in the assessment of the adequacy of the allowance is the quality of the loan portfolio from a past due standpoint. Below is a table, which details the past due balances at September 30, 2008 compared to those at year-end 2007 and the corresponding change related to those two periods.
Increase
Loans Past Due: September 30, 2008 December 31, 2007 (Decrease)
--------------- ------------------ ----------------- ----------
30-59 days $1,643,367 $2,155,411 $(512,044)
60-89 days 163,400 825,107 (661,707)
90 days and greater 1,638,109 1,484,451 153,658
Non accrual loans 3,618,951 4,532,120 (913,169)
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From year-end 2007 to September 30, 2008, overall past due and non-accrual loans have decreased by $1.9 million. A majority of the activity is related to reductions in 30 to 89 days past due and non-accrual loans being partially offset by an increase in loans past due 90 days or more.
Loans past due thirty to fifty-nine days, sixty to eighty-nine days and non-accrual loans decreased $2.1 million from December 31, 2007 to September 30, 2008. Seven loans charged off in the first half of 2008 comprise nearly all of the decrease. Most of the notes were collateralized by real estate. One loan was collateralized by a high end boat. The collateral from the former notes is currently being carried in other assets at market value less costs to sell. At the time of charge off there was $221,000 in previously allocated reserves on the commercial real estate notes.
Including the charge off activity above, net charge-offs for the third quarter and first nine months of 2008 were $207,000 and $797,000 which was an increase of $115,000 over net charge-offs of $92,000 recorded for the third quarter of 2007 and $557,000 more than the
$240,000 charged off in the first nine months of 2007. The corresponding ratio of net charge-offs to average loans was 0.38% and 0.48% for the third quarter and first nine months of 2008 compared to levels of 0.16% and 0.15% for the similar periods in 2007. Given the rise in non performing assets over the past two years, it is likely that charge off ratios may remain elevated for a period of time.
Other assets rose $1.6 million since December 31, 2007. The most significant categories in other assets are other real estate owned and repossessed assets. At September 30, 2008, the balances of other real estate owned and repossessed assets were $2.4 million and $130,000 respectively. When the collateral supporting a borrowing is relinquished by customers through the collection process; the assets are written to fair value based on a professional appraisal or other common means of valuation and held in one of the above accounts until they can be sold. At September 30, 2008 there were fourteen properties and one high end boat being held for sale. If any relinquished asset is sold for less than it is being held or experiences a decline in market value during the holding period, further losses could result. Currently, the fair values of real estate appear to be stable however the selling period has increased dramatically.
Deposit balances were $221.3 million at September 30, 2008 down from $237.9 million at December 31, 2007. Total deposit erosion since year-end was $16.7 million or 7%. Non interest bearing deposits grew $1.9 million since year-end 2007. Interest bearing checking accounts, money market and savings balances rose $3.8 million. Growth is due to several of the Bank's large public fund customers increasing their holdings since year-end. The growth in the above products was more than offset by a $22.3 million decline in time deposits since December 31, 2007. Local time deposits made up $13.1 million of the total decline and $9.2 million was brokered deposit maturities. The concentration of brokered deposits to total deposits was reduced to 38% at September 30, 2008 from 39% at December 31, 2007. The Bank strives to continue decreasing its dependency on brokered funds and begin to rely more on local deposits gathered as a result of its expanded branch network.
Shareholders' equity totaled $15.7 million at September 30, 2008 and $15.6 million at December 31, 2007. The increase is a result of the earnings recorded in the first nine months of the year. There was relatively little change in accumulated other comprehensive income (security market value adjustments) since year end 2007.
RESULTS OF OPERATIONS
Net income for the first nine months of 2008 was $55,000 which was $88,000 less than the similar period in 2007. The corresponding basic and diluted earnings per share for the first nine months of 2008 were $0.04 compared to $0.10 for 2007. Year to date 2008 earnings were impacted by a lower net interest income coupled with higher depreciation costs associated with the new branch building in the Grand Haven market, higher credit administration expenses and higher FDIC insurance premiums.
The Company recorded net income of $12,000 for the third quarter of 2008 while the same period in 2007 netted losses of $103,000. The corresponding basic and diluted earnings per
share were $0.01 for the third quarter of 2008 and $(0.07) for the similar period in 2007. The recorded net loss in 2007's third quarter stemmed mostly from high loan loss provision.
For the first nine months of 2008, the annualized return on the Company's
average total assets was 0.03% which is down from 0.07% annualized return for
the same period in 2007. The Company's annualized return on average equity was
0.47% for the first nine months of 2008 and 1.17% for the first nine months of
2007. Conversely, the third quarter results of 2008 exceeded that of 2007
because of the differences in net income. The annualized return on the Company's
average total assets and average equity were 0.02% and 0.31% respectively for
the third quarter of 2008. The same ratios for the third quarter of 2007 were
(0.16)% and (2.51)%. The ratio of average equity to average assets was 5.77% and
5.94% for the first nine months and third quarter of 2008 and 6.41% and 6.21%
for the same periods in 2007.
As mentioned above, significant differences between the operating results of the first nine months of 2007 and 2008 are the net interest income and the corresponding net interest margin. The following table sets forth certain information relating to the Company's consolidated average interest earning assets and interest bearing liabilities and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing annualized income or expenses by the average daily balance of assets or liabilities, respectively, for the periods presented.
Nine months ended September 30,
---------------------------------------------------------------------------
2008 2007
------------------------------------ ------------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------------ ----------- ------- ------------ ----------- -------
Assets
Federal funds sold and interest-
bearing deposits with other
financial institutions $ 10,785,241 $ 189,341 2.34% $ 3,101,880 $ 121,238 5.21%
Securities 19,960,690 749,702 5.01 19,421,139 718,767 4.93
Loans (including held for sale and
non accrual) 223,616,549 11,446,961 6.83 216,205,928 12,844,252 7.92
------------ ----------- ------ ------------ ----------- ------
254,362,480 12,386,004 6.49 238,728,947 13,684,257 7.64
Other assets 16,851,670 16,441,876
------------ ------------
$271,214,150 $255,170,823
============ ============
Liabilities and Shareholders' Equity
Interest-bearing deposits $217,399,485 $ 6,331,688 3.88 $199,874,672 $ 6,628,072 4.42
Federal funds purchased, repurchase
agreements and Federal
Reserve Bank borrowings 4,523,032 53,718 1.58 8,820,177 279,755 4.23
Subordinated Debentures, Note
Payable and Federal Home Loan
Bank Advances 14,700,684 598,379 5.43 11,041,557 546,643 6.60
------------ ----------- ------ ------------ ----------- ------
236,623,201 6,983,785 3.94 219,736,406 7,454,470 4.52
----------- -----------
Non-interest bearing deposits 18,200,482 18,193,034
Other liabilities 736,816 875,926
Shareholders' Equity 15,653,651 16,365,457
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
------------ ------------
$271,214,150 $255,170,823
============ ============
Net interest income (tax equivalent
basis) 5,402,219 6,229,787
Net interest spread on earning assets
(tax equivalent basis) 2.56% 3.12%
====== ======
Net interest margin on earning assets
. . .
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