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EX-31.1 - EXHIBIT 31.1 - COMMUNITY SHORES BANK CORPexh_311.htm
EX-32.1 - EXHIBIT 32.1 - COMMUNITY SHORES BANK CORPexh_321.htm
EX-31.2 - EXHIBIT 31.2 - COMMUNITY SHORES BANK CORPexh_312.htm
EX-32.2 - EXHIBIT 32.2 - COMMUNITY SHORES BANK CORPexh_322.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012                                                                           

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                                                                                           to ____________________________________

Commission File Number: 000-51166 
 
Community Shores Bank Corporation 
(Exact name of registration as specified in its charter)
   
Michigan
38-3423227
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
   
1030 W. Norton Avenue, Muskegon, MI
49441
(Address of principal executive offices)
(Zip Code)
   
(231) 780-1800
(Registrant’s telephone number, including area code)
 
 
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x  Yes oNo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
o  Yes  x  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o     Accelerated filer o      Non-accelerated filer o       Smaller reporting company x
                                                                                  (Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes x  No

At August 1, 2012, 1,468,800 shares of common stock were outstanding.
 
 
 

 
Community Shores Bank Corporation Index


 
 
 
 

 
PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

   
June 30,
   
December 31,
 
   
2012
 
2011
 
   
(unaudited)
       
ASSETS
           
Cash and due from financial institutions
  $ 3,200,935     $ 2,426,142  
Interest-bearing deposits in other financial institutions
    15,242,760       6,493,426  
    Total cash and cash equivalents
    18,443,695       8,919,568  
Securities available for sale (at fair value)
    36,881,714       34,572,103  
Loans held for sale
    6,070,473       5,534,983  
Loans
    132,373,910       149,658,931  
Less: Allowance for loan losses
    4,321,297       5,299,454  
    Net loans
    128,052,613       144,359,477  
Federal Home Loan Bank stock (at cost)
    450,800       450,800  
Premises and equipment, net
    9,448,046       10,404,865  
Accrued interest receivable
    648,722       746,143  
Foreclosed assets
    3,356,404       3,276,838  
Other assets
    994,996       386,524  
            Total assets
  $ 204,347,463     $ 208,651,301  
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Deposits
               
    Non-interest-bearing
  $ 35,565,711     $ 33,281,198  
    Interest-bearing
    148,052,497       158,264,038  
            Total deposits
    183,618,208       191,545,236  
Federal funds purchased and repurchase agreements
    10,993,728       7,814,745  
Subordinated debentures
    4,500,000       4,500,000  
Notes payable
    5,000,000       5,000,000  
Accrued expenses and other liabilities
    1,425,761       1,211,702  
            Total liabilities
    205,537,697       210,071,683  
Shareholders’ equity
               
    Preferred Stock, no par value: 1,000,000 shares
               
      authorized and none issued
    0       0  
    Common Stock, no par value: 9,000,000 shares authorized;
               
      1,468,800 issued and outstanding
    13,296,691       13,296,691  
    Retained deficit
    (14,826,896 )     (15,084,431 )
    Accumulated other comprehensive income
    339,971       367,358  
    Total shareholders’ equity
    (1,190,234 )     (1,420,382 )
    Total liabilities and shareholders’ equity
  $ 204,347,463     $ 208,651,301  

See accompanying notes to consolidated financial statements.

 
-1-

 
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
 
   
Three Months
   
Three Months
   
Six Months
   
Six Months
 
   
Ended
   
Ended
   
Ended
   
Ended
 
   
June 30, 2012
   
June 30, 2011
   
June 30, 2012
   
June 30, 2011
 
Interest and dividend income
                       
    Loans, including fees
  $ 2,100,364     $ 2,534,972     $ 4,253,369     $ 5,100,053  
    Securities (including FHLB dividends)
    174,501       206,808       349,695       424,722  
    Federal funds sold and other income
    11,880       12,736       23,615       26,430  
      Total interest income
    2,286,745       2,754,516       4,626,679       5,551,205  
Interest expense
                               
    Deposits
    356,395       764,822       760,668       1,576,417  
    Repurchase agreements, federal funds purchased, and other debt
    21,629       20,115       39,019       31,617  
    Federal Home Loan Bank advances and notes payable
    106,865       104,161       214,844       207,051  
      Total interest expense
    484,889       889,098       1,014,531       1,815,085  
Net Interest Income
    1,801,856       1,865,418       3,612,148       3,736,120  
Provision for loan losses
    0       497,921       75,035       1,202,426  
Net Interest Income After Provision for Loan Losses
    1,801,856       1,367,497       3,537,113       2,533,694  
Non-interest income
                               
    Service charges on deposit accounts
    174,598       197,834       338,808       374,647  
    Mortgage loan referral fees
    11,162       7,841       14,441       12,105  
    Gain on sale of loans
    64,843       13,622       102,932       171,182  
    Gain on sale of securities
    0       0       2,856       0  
    Gain (loss) on sale of foreclosed assets
    6,364       (4,269 )     (42,433 )     (5,068 )
    Gain on sale of premises and equipment
    208,389       0       208,389       0  
    Other
    109,444       145,157       251,453       326,829  
      Total non-interest income
    574,800       360,185       876,446       879,695  
Non-interest expense
                               
    Salaries and employee benefits
    918,958       1,027,091       1,888,722       2,052,431  
    Occupancy
    158,642       155,485       321,485       336,846  
    Furniture and equipment
    102,814       136,515       203,985       269,001  
    Advertising
    13,472       11,590       27,352       20,935  
    Data processing
    148,942       118,207       282,461       250,613  
    Professional services
    72,456       85,099       148,108       179,937  
    Foreclosed asset impairment
    93,878       225,062       185,020       392,928  
    Other
    545,858       490,952       1,098,891       1,167,236  
      Total non-interest expense
    2,055,020       2,250,001       4,156,024       4,669,927  
Income (Loss) Before Federal Income Taxes
    321,636       (522,319 )     257,535       (1,256,538 )
Federal income tax expense (benefit)
    0       0       0       0  
Net Income (Loss)
  $ 321,636     $ (522,319 )   $ 257,535     $ (1,256,538 )
Weighted average shares outstanding
    1,468,800       1,468,800       1,468,800       1,468,800  
Diluted average shares outstanding
    1,468,800       1,468,800       1,468,800       1,468,800  
Basic earnings (loss) per share
  $ 0.22     $ (0.36 )   $ 0.18     $ (0.86 )
Diluted earnings (loss) per share
  $ 0.22     $ (0.36 )   $ 0.18     $ (0.86 )
 
See accompanying notes to consolidated financial statements.
 
 
-2-

 
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
 
   
Three Months
   
Three Months
   
Six Months
   
Six Months
 
   
Ended
   
Ended
   
Ended
   
Ended
 
   
June 30, 2012
   
June 30, 2011
   
June 30, 2012
   
June 30, 2011
 
                         
Net income (loss)
  $ 321,636     $ (522,319 )   $ 257,535     $ (1,256,538 )
                                 
Other comprehensive income (loss):
                               
    Unrealized holding gains and (losses) on
                               
      available for sale securities
    14,906       194,750       (24,531 )     224,936  
    Less reclassification adjustments for gains later
                               
      recognized in income
    0       0       (2,856 )     0  
    Net unrealized gain (loss)
    14,906       194,750       (27,387 )     224,936  
    Tax effect
    0       0       0       0  
    Total other comprehensive income (loss)
    14,906       194,750       (27,387 )     224,936  
                                 
Comprehensive income (loss)
  $ 336,542     $ (327,569 )   $ 230,148     $ (1,031,602 )
 
See accompanying notes to consolidated financial statements.
 
 
-3-

 
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(UNAUDITED)
 
                     
Accumulated
       
                     
Other
   
Total
 
         
Common
   
Retained
   
Comprehensive
   
Shareholders’
 
   
Shares
   
Stock
   
Deficit
   
Income
   
Equity
 
                               
Balance at January 1, 2011
    1,468,800     $ 13,296,691     $ (12,617,022 )   $ 166,118     $ 845,787  
                                         
    Net loss
                    (1,256,538 )             (1,256,538 )
    Other comprehensive income
                            224,936       224,936  
                                         
Balance at June 30, 2011
    1,468,800     $ 13,296,691     $ (13,873,560 )   $ 391,054     $ (185,815 )
                                         
Balance at January 1, 2012
    1,468,800     $ 13,296,691     $ (15,084,431 )   $ 367,358     $ (1,420,382 )
                                         
    Net income
                    257,535               257,535  
    Other comprehensive loss
                            (27,387 )     (27,387 )
                                         
Balance at June 30, 2012
    1,468,800     $ 13,296,691     $ (14,826,896 )   $ 339,971     $ (1,190,234 )
 
See accompanying notes to consolidated financial statements.

 
-4-

 
COMMUNITY SHORES BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
 
   
Six Months Ended
   
Six Months Ended
 
   
June 30, 2012
 
June 30, 2011
 
Cash flows from operating activities
           
    Net income (loss)
  $ 257,535     $ (1,256,538 )
    Adjustments to reconcile net income (loss) to net cash
               
      from operating activities:
               
            Provision for loan losses
    75,035       1,202,426  
            Depreciation and amortization
    202,173       267,155  
            Net amortization of securities
    148,636       118,575  
            Net realized gain on sale of securities
    (2,856 )     0  
            Net realized gain on sale of loans
    (102,932 )     (171,182 )
            Net realized gain on sale of premises and equipment
    (208,389 )     0  
            Net realized loss on sale of foreclosed assets
    42,433       5,068  
            Foreclosed asset impairment
    185,020       392,928  
            Originations of loans for sale
    (6,385,590 )     (8,104,666 )
            Proceeds from loan sales
    5,953,032       6,474,553  
            Net change in:
               
                Accrued interest receivable and other assets
    (623,857 )     170,728  
                Accrued interest payable and other liabilities
    214,059       248,947  
                    Net cash used in operating activities
    (245,701 )     (652,006 )
Cash flows from investing activities
               
    Activity in available for sale securities:
               
            Sales
    257,997       0  
            Maturities, prepayments and calls
    4,548,446       8,576,627  
            Purchases
    (7,289,221 )     (7,191,746 )
    Loan originations and payments, net
    15,365,675       4,208,981  
    Redemption of Federal Home Loan Bank stock
    0       29,000  
    Proceeds from the sale of capital assets
    998,524       0  
    Additions to premises and equipment, net
    (35,489 )     (45,123 )
    Proceeds from the sale of foreclosed assets
    671,941       138,968  
                Net cash from investing activities
    14,517,873       5,716,707  
Cash flows from financing activities
               
    Net change in deposits
    (7,927,028 )     (16,628,815 )
    Net change in federal funds purchased and
               
      repurchase agreements
    3,178,983       3,248,171  
            Net cash used in financing activities
    (4,748,045 )     (13,380,644 )
Net change in cash and cash equivalents
    9,524,127       (8,315,943 )
Beginning cash and cash equivalents
    8,919,568       23,639,873  
Ending cash and cash equivalents
  $ 18,443,695     $ 15,323,930  
Supplemental cash flow information:
               
    Cash paid during the period for interest
  $ 806,838     $ 1,633,959  
    Transfers from loans to foreclosed assets
    1,051,028       706,617  
    Foreclosed asset sales financed by the Company
    72,068       245,419  
 
See accompanying notes to consolidated financial statements.
 
 
-5-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1. 
BASIS OF PRESENTATION AND RECENT DEVELOPMENTS:
 
The unaudited, consolidated financial statements as of and for the three and six month periods ended June 30, 2012 include the consolidated results of operations of Community Shores Bank Corporation (“Company”) and its wholly-owned subsidiaries, Community Shores Financial Services (“CS Financial Services”), and Community Shores Bank (the “Bank”), and the Bank’s wholly-owned subsidiary, Community Shores Mortgage Company (the “Mortgage Company”) and the Mortgage Company’s wholly-owned subsidiary, Berryfield Development, LLC (“Berryfield”). Community Shores Capital Trust I (“the Trust”) is not consolidated and exists solely to issue capital securities. These consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Article 8 of Regulation S-X and do not include all disclosures required by generally accepted accounting principles for a complete presentation of the Company’s financial condition and results of operations.  In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair representation of the results of operations for such periods.  The results for the period ended June 30, 2012 should not be considered as indicative of results for a full year.  For further information, refer to the consolidated financial statements and footnotes included in the Company’s annual report on Form 10-K for the period ended December 31, 2011. Some items in the prior year financial statements may be reclassified to conform to the current presentation.

In May 2011, the FASB issued an amendment to achieve common fair value measurement and disclosure requirements between U.S. and International accounting principles. Overall, the guidance is consistent with existing U.S. accounting principles; however, there are some amendments that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements.  For public companies, the amendments in this guidance are effective for interim and annual reporting periods beginning after December 15, 2011. The effect of adopting this new guidance was disclosure-related only and had no impact on the Company’s results of operations.

In June 2011, the FASB amended existing guidance and eliminated the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity. The amendment requires that comprehensive income be presented in either a single continuous statement or in two separate consecutive statements.  For public companies, the amendments in this guidance are effective as of the beginning of a fiscal reporting year, and interim periods within that year, that begins after December 15, 2011. The Company adopted this amendment by adding a consolidated statement of comprehensive income immediately following the consolidated statements of income.
 
 
-6-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.
BASIS OF PRESENTATION AND RECENT DEVELOPMENTS (Continued):

Since 2008, the Company has experienced consolidated losses stemming from deterioration in credit quality and real estate values requiring the need for large loan loss provisions and impairments of foreclosed real estate. As a result primarily of the sustained losses, the Bank’s capital ratios declined. The Bank has been deemed undercapitalized since December 31, 2010 according to regulatory capital standards. At that time, the Bank had a total risk-based capital ratio of 7.06%. In 2012, after two quarters of profitability and a reduction of higher risk-weighted assets, the Bank’s total risk- based capital ratio increased to 7.40%. In spite of the improving total risk-based capital ratio, the Bank remains undercapitalized as of June 30, 2012.

As a result of deteriorating asset quality, poor earnings and falling capital ratios, the Bank endured additional regulatory scrutiny and entered into a Consent Order with the Federal Deposit Insurance Corporation (“FDIC”) and the State of Michigan’s Office of Financial and Insurance Regulation (“OFIR”), its primary regulators, on September 2, 2010. The Bank agreed to the terms of the Consent Order without admitting or denying any charge of unsafe or unsound banking practices relating to capital, asset quality, or earnings. The Consent Order imposes no fines or penalties on the Bank. The Consent Order will remain in effect and enforceable until it is modified, terminated, suspended, or set aside by the FDIC and OFIR. Under the Consent Order the Bank was required, within 90 days of September 2, 2010, to have and maintain its level of Tier 1 capital, as a percentage of its total assets, at a minimum of 8.5%, and its level of qualifying total capital, as a percentage of risk-weighted assets, at a minimum of 11%. The Bank was not able to meet these requirements within the required 90-day period and remains out of compliance with the Consent Order as of June 30, 2012.

The lack of financial soundness of the Bank and the Company’s inability to serve as a source of strength for the Bank resulted in the board of directors entering into a Written Agreement with the Federal Reserve Bank of Chicago (the “FRB”), the Company’s primary regulator. The Written Agreement became effective on December 16, 2010, when it was executed by the FRB. The Written Agreement provides that: (i) the Company must take appropriate steps to fully utilize its financial and managerial resources to serve as a source of strength to the Bank; (ii) the Company may not declare or pay any dividends or take dividends or any other payment representing a reduction in capital from the Bank or make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior FRB approval; (iii) the Company may not incur, increase or guarantee any debt or purchase or redeem any shares of its stock without prior FRB approval; (iv) the Company must submit a written statement of its planned sources and uses of cash for debt service, operating expenses and other purposes to the FRB within 30 days of the Written Agreement; (v) the Company shall take all necessary actions to ensure that the Bank, the Company and all nonbank subsidiaries of both the Bank and the Company comply with sections 23A and 23B of the Federal Reserve Act and Regulation W of the Board of Governors (12 C.F.R. Part 223) in all transactions between affiliates; (vi) the Company may not appoint any new director or senior executive officer, or change the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position, without prior regulatory approval; and finally (vii) within 30 days after the end of each calendar quarter following the date of the Written Agreement, the board of directors shall submit to the FRB written progress reports detailing the form and manner of all actions taken to secure compliance with the provisions of the Written Agreement as well as current copies of the parent company only financial statements. The Company has not yet been able to meet the obligation detailed in part (i) above; as the Company currently has negative equity and limited resources with which to support the capital needs of the Bank.
 
 
-7-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.
BASIS OF PRESENTATION AND RECENT DEVELOPMENTS (Continued):

The Company’s main liquidity resource is its cash account balance which, as of June 30, 2012, was approximately $37,000. At this time, the Company has chosen to postpone the decision to take advantage of the Jumpstart Our Business Startups Act (the “JOBS Act”) and deregister as a public company. Management and the Board of Directors are considering many options for obtaining funding for the Company and do not believe it would be in the best interest of the Company to limit its options by deregistering. It is projected that the level of cash held at June 30, 2012 is adequate to support the Company’s overhead expenses through year-end 2012.
 
On January 3, 2011, the Company was not able to repay its $5 million term loan when it came due. The Company does not have the resources to pay the outstanding principal and does not expect to have it in the near future. The Company did not make the last nine contractual quarterly interest payments. The total interest due to Fifth Third at year-end 2011 was $458,000. The Company continues to accrue interest on the term loan and at June 30, 2012, the total interest due Fifth Third was $609,000. Since the Company presently does not have sufficient funds to pay off the term loan’s principal and accrued interest, Fifth Third has a right to foreclose on the Bank’s stock which collateralizes the term loan.

On August 17, 2011, the Bank was issued a Supervisory Prompt Corrective Action Directive (the “Directive”) because of its undercapitalized capital category at December 31, 2010, its failure to submit a capital restoration plan that satisfies the requirements stipulated in the FDIC Rules and Regulations, and the continued deterioration of the Bank. The Directive stipulated that the Bank be restored to an “adequately capitalized” capital category within 60 days of the issuance of the Directive. During the 60 days, the board made efforts to secure funding and comply with the Directive but was not successful. As such, the Bank was not in compliance with the Directive at the end of 60 days and remains out of compliance. The board informed the FDIC in a letter dated October 14, 2011 that it was unable to comply with the Directive. There has been no further communications with the FDIC regarding the Directive. The board’s efforts to garner capital for the Bank are expected to continue.

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

The Company’s net losses, failure to repay its term loan at maturity, non-compliance with the higher capital ratios of the Directive and the Consent Order, and the provisions of the Written Agreement raise substantial doubt about the Company’s ability to continue as a going concern. As a result of this substantial doubt, our auditors added an explanatory paragraph to their opinion on the Company’s December 31, 2011 and 2010 consolidated financial statements expressing substantial doubt about the Company’s ability to continue as a going concern. These financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
 
 
-8-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 2.     SECURITIES AVAILABLE FOR SALE:

The following tables represent the securities held in the Company’s portfolio at June 30, 2012 and at December 31, 2011:

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
June 30, 2012
 
Cost
   
Gains
   
Losses
   
Value
 
                         
    US Treasury
  $ 5,557,094     $ 47,004     $ (583 )   $ 5,603,515  
    US Government and federal agency
    18,538,401       245,308       (2,195 )     18,781,514  
    Municipals
    2,263,868       100,039       0       2,363,907  
    Mortgage-backed and collateralized
                               
      mortgage obligations– residential
    9,861,482       283,183       (11,887 )     10,132,778  
    $ 36,220,845     $ 675,534     $ (14,665 )   $ 36,881,714  

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
December 31, 2011
 
Cost
   
Gains
   
Losses
   
Value
 
                         
    US Treasury
  $ 4,041,881     $ 25,775     $ 0     $ 4,067,656  
    US Government and federal agency
    15,341,362       239,037       (7,811 )     15,572,588  
    Municipals
    2,767,463       123,957       0       2,891,420  
    Mortgage-backed and collateralized
                               
      mortgage obligations– residential
    11,733,141       317,565       (10,267 )     12,040,439  
    $ 33,883,847     $ 706,334     $ (18,078 )   $ 34,572,103  

The amortized cost and fair value of the securities portfolio are shown by expected maturity.  Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment fees.  Below is the schedule of contractual maturities for securities held at June 30, 2012:

   
Amortized
   
Fair
 
   
Cost
   
Value
 
Due in one year or less
  $ 5,512,042     $ 5,539,503  
Due from one to five years
    18,715,152       18,990,062  
Due from five to ten years
    2,132,169       2,219,371  
Due in more than ten years
    0       0  
Mortgage-backed and collateralized
               
    mortgage obligations – residential
    9,861,482       10,132,778  
    $ 36,220,845     $ 36,881,714  

 
-9-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
2.      SECURITIES AVAILABLE FOR SALE (Continued):

Below is the table of securities with unrealized losses, aggregated by investment category and length of time such securities were in an unrealized loss position at June 30, 2012 and December 31, 2011:

   
Less than 12 Months
   
12 Months or Longer
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
June 30, 2012
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
US Treasury
  $ 512,266     $ (583 )   $ 0     $ 0     $ 512,266     $ (583 )
US Government and federal agency
    1,614,517       (2,195 )     0       0       1,614,517       (2,195 )
Mortgage-backed and collateralized
                                               
    mortgage obligations - residential
    781,442       (4,580 )     315,604       (7,307 )     1,097,046       (11,887 )
    $ 2,908,225     $ (7,358 )   $ 315,604     $ (7,307 )   $ 3,223,829     $ (14,665 )

   
Less than 12 Months
   
12 Months or Longer
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
December 31, 2011
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
US Government and federal agency
  $ 2,060,693     $ (7,811 )   $ 0     $ 0     $ 2,060,693     $ (7,811 )
Mortgage-backed and collateralized
                                               
    mortgage obligations - residential
    817,615       (4,240 )     1,215,921       (6,027 )     2,033,536       (10,267 )
    $ 2,878,308     $ (12,051 )   $ 1,215,921     $ (6,027 )   $ 4,094,229     $ (18,078 )

No securities were sold in the three months ended June 30, 2012.  There was one security sold in the first six months of 2012.  Management chose to remove the security from the portfolio because it no longer complied with the Bank’s internal investment policy.  Proceeds from the sale were $257,997 resulting in a realized gain of $2,856.  There were no sales of securities for the six months ended June 30, 2011.
 
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
 
 
-10-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2.      SECURITIES AVAILABLE FOR SALE (Continued):

amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

At June 30, 2012, seven debt securities had unrealized losses with aggregate depreciation of 0.45% from the amortized cost basis. All seven securities are issued by a government agency. It is likely that these debt securities will be retained given the fact that they are pledged to various public funds. The reported decline in value is not material and is deemed to be market driven. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at June 30, 2012.

Mortgage-backed and Collateralized Mortgage Obligation Securities

At June 30, 2012, 100% of the mortgage-backed and collateralized mortgage obligation securities held by the Company were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae, Freddie Mac and Ginnie Mae, institutions which the government has affirmed its commitment to support. The unrealized loss associated with these securities was 1.07% of amortized cost at June 30, 2012. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at June 30, 2012.

3.
LOANS

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

   
June 30, 2012
 
December 31, 2011
 
Commercial
  $ 42,594,280     $ 50,062,289  
Commercial Real Estate:
               
    General
    52,470,622       59,985,723  
    Construction
    5,895,146       6,425,041  
Consumer:
               
    Lines of credit
    12,225,130       13,376,689  
    Other
    2,137,599       2,370,625  
    Credit card
    523,224       527,858  
Residential
    16,570,158       16,942,989  
      132,416,159       149,691,214  
Less:  Allowance for loan losses
    (4,321,297 )     (5,299,454 )
      Net deferred loan fees
    (42,249 )     (32,283 )
Loans, net
  $ 128,052,613     $ 144,359,477  

 
-11-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
4.
ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS

The following tables present the activity in the allowance for loan losses for the three month periods ending June 30, 2012 and 2011 by portfolio segment:

         
Commercial
                         
Three Months Ended June 30, 2012
 
Commercial
   
Real Estate
   
Consumer
   
Residential
   
Unallocated
   
Total
 
Allowance for loan losses:
                                   
    Beginning balance
  $ 1,138,063     $ 2,486,708     $ 513,260     $ 206,001     $ 90,071     $ 4,434,103  
      Charge-offs
    (24,277 )     (94,505 )     (16,693 )     (11,392 )     0       (146,867 )
      Recoveries
    18,439       13,523       2,099       0       0       34,061  
      Provision for loan losses
    224,678       (153,745 )     (56,199 )     (903 )     (13,831 )     0  
    Ending balance
  $ 1,356,903     $ 2,251,981     $ 442,467     $ 193,706     $ 76,240     $ 4,321,297  

         
Commercial
                   
Three Months Ended June 30, 2011
 
Commercial
   
Real Estate
   
Consumer
   
Residential
   
Total
 
Allowance for loan losses:
                             
    Beginning balance
  $ 1,160,906     $ 3,205,039     $ 631,316     $ 258,607     $ 5,255,868  
      Charge-offs
    (225,106 )     (586,086 )     (12,361 )     (32,663 )     (856,216 )
      Recoveries
    8,132       3,501       16,286       10,142       38,061  
      Provision for loan losses
    543,430       93,356       (142,264 )     3,399       497,921  
    Ending balance
  $ 1,487,362     $ 2,715,810     $ 492,977     $ 239,485     $ 4,935,634  

 
-12-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

The following tables present the activity in the allowance for loan losses for the six month periods ending June 30, 2012 and 2011 by portfolio segment:

         
Commercial
                         
Six Months Ended June 30, 2012
 
Commercial
   
Real Estate
   
Consumer
   
Residential
   
Unallocated
   
Total
 
Allowance for loan losses:
                                   
    Beginning balance
  $ 1,309,632     $ 3,386,433     $ 410,001     $ 193,388     $ 0     $ 5,299,454  
      Charge-offs
    (213,069 )     (857,205 )     (31,481 )     (11,392 )     0       (1,113,147 )
      Recoveries
    26,548       13,523       19,884       0       0       59,955  
      Provision for loan losses
    233,792       (290,770 )     44,063       11,710       76,240       75,035  
    Ending balance
  $ 1,356,903     $ 2,251,981     $ 442,467     $ 193,706     $ 76,240     $ 4,321,297  

         
Commercial
                   
Six Months Ended June 30, 2011
 
Commercial
   
Real Estate
   
Consumer
   
Residential
   
Total
 
Allowance for loan losses:
                             
    Beginning balance
  $ 1,218,865     $ 2,896,176     $ 546,603     $ 130,263     $ 4,791,907  
      Charge-offs
    (359,807 )     (674,324 )     (72,819 )     (32,663 )     (1,139,613 )
      Recoveries
    35,780       6,999       27,993       10,142       80,914  
      Provision for loan losses
    592,524       486,959       (8,800 )     131,743       1,202,426  
    Ending balance
  $ 1,487,362     $ 2,715,810     $ 492,977     $ 239,485     $ 4,935,634  
 
 
-13-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
4.     ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as of June 30, 2012 and December 31, 2011:

         
Commercial
                         
June 30, 2012
 
Commercial
   
Real Estate
   
Consumer
   
Residential
   
Unallocated
   
Total
 
Allowance for loan losses:
                                   
    Ending allowance balance attributable to loans:
                                   
      Individually evaluated for impairment
  $ 793,384     $ 1,418,184     $ 182,739     $ 121,649     $ 0     $ 2,515,956  
      Collectively evaluated for impairment
    563,519       833,797       259,728       72,057       0       1,729,101  
      Unallocated
    0       0       0       0       76,240       76,240  
            Total ending allowance balance
  $ 1,356,903     $ 2,251,981     $ 442,467     $ 193,706     $ 76,240     $ 4,321,297  
                                                 
Loans:
                                               
      Individually evaluated for impairment
  $ 4,218,406     $ 8,444,494     $ 364,276     $ 848,223     $ 0     $ 13,875,399  
      Collectively evaluated for impairment
    38,494,387       50,322,450       14,538,937       15,725,088       0       119,080,862  
            Total ending loans balance
  $ 42,712,793     $ 58,766,944     $ 14,903,213     $ 16,573,311     $ 0     $ 132,956,261  

         
Commercial
                   
December 31, 2011
 
Commercial
   
Real Estate
   
Consumer
   
Residential
   
Total
 
Allowance for loan losses:
                             
    Ending allowance balance attributable to loans:
                             
      Individually evaluated for impairment
  $ 466,001     $ 2,312,396     $ 109,309     $ 103,393     $ 2,991,099  
      Collectively evaluated for impairment
    843,631       1,074,037       300,692       89,995       2,308,355  
            Total ending allowance balance
  $ 1,309,632     $ 3,386,433     $ 410,001     $ 193,388     $ 5,299,454  
                                         
Loans:
                                       
      Individually evaluated for impairment
  $ 3,930,572     $ 11,063,154     $ 274,700     $ 595,598     $ 15,864,024  
      Collectively evaluated for impairment
    46,310,136       55,826,461       16,025,489       16,429,725       134,591,811  
            Total ending loans balance
  $ 50,240,708     $ 66,889,615     $ 16,300,189     $ 17,025,323     $ 150,455,835  
 
 
-14-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

The following tables present loans individually evaluated for impairment by class of loans as of June 30, 2012 and December 31, 2011.  For purposes of this disclosure, the Company reports unpaid principal balance net of partial charge-offs.

                     
Three Months
   
Three Months
   
Three Months
   
Six Months
   
Six Months
   
Six Months
 
         
Unpaid
         
Average
   
Interest
   
Cash Basis
   
Average
   
Interest
   
Cash Basis
 
   
Recorded
   
Principal
   
Related
   
Recorded
   
Income
   
Interest
   
Recorded
   
Income
   
Interest
 
June 30, 2012
 
Investment
   
Balance
   
Allowance
   
Investment
   
Recognized
   
Recognized
   
Investment
   
Recognized
   
Recognized
 
With no related allowance recorded:
                                                     
Commercial
  $ 2,233,517     $ 2,231,960     $ 0     $ 2,395,169     $ 13,599     $ 13,599     $ 2,556,893     $ 27,313     $ 27,198  
Commercial Real Estate:
                                                                       
    General
    3,563,035       3,563,478       0       2,438,933       10,489       10,486       2,333,487       12,921       12,912  
    Construction
    0       0       0       214,764       0       0       303,937       0       0  
Consumer:
                                                                       
    Lines of credit
    41,733       41,670       0       41,773       301       301       50,178       790       602  
    Other
    20,333       20,333       0       20,374       0       0       20,415       0       0  
    Credit card
    0       0       0       0       0       0       0       0       0  
Residential
    377,427       377,905       0       313,229       497       497       249,108       995       995  
            Subtotal
  $ 6,236,045     $ 6,235,346     $ 0     $ 5,424,242     $ 24,886     $ 24,883     $ 5,514,018     $ 42,019     $ 41,707  
                                                                         
With an allowance recorded:
                                                                       
Commercial
  $ 1,984,889     $ 1,984,404     $ 793,384     $ 1,826,765     $ 9,250     $ 8,610     $ 1,800,707     $ 18,773     $ 16,716  
Commercial Real Estate:
                                                                       
    General
    2,826,858       2,822,823       298,752       3,282,185       36,109       36,109       3,712,164       78,747       47,763  
    Construction
    2,054,601       2,054,601       1,119,432       2,045,270       0       0       2,002,868       0       0  
Consumer:
                                                                       
    Lines of credit
    190,911       190,703       95,879       222,020       1,317       1,204       200,654       2,854       2,848  
    Other
    111,299       111,035       86,860       109,821       518       483       110,092       1,001       966  
    Credit card
    0       0       0       0       0       0       352       0       0  
Residential
    470,796       469,468       121,649       539,980       3,846       3,646       529,993       7,477       7,196  
            Subtotal
  $ 7,639,354     $ 7,633,034     $ 2,515,956     $ 8,026,041     $ 51,040     $ 50,052     $ 8,356,830     $ 108,852     $ 75,489  
Total
  $ 13,875,399     $ 13,868,380     $ 2,515,956     $ 13,450,283     $ 75,926     $ 74,935     $ 13,870,848     $ 150,871     $ 117,196  

 
-15-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

                     
Twelve Months
   
Twelve Months
   
Twelve Months
 
         
Unpaid
         
Average
   
Interest
   
Cash Basis
 
   
Recorded
   
Principal
   
Related
   
Recorded
   
Income
   
Interest
 
December 31, 2011
 
Investment
   
Balance
   
Allowance
   
Investment
   
Recognized
   
Recognized
 
With no related allowance recorded:
                                   
Commercial
  $ 2,591,467     $ 2,589,356     $ 0     $ 3,511,753     $ 55,237     $ 55,237  
Commercial Real Estate:
                                               
    General
    4,388,271       4,377,406       0       3,265,902       123,083       107,620  
    Construction
    227,842       227,842       0       511,659       0       0  
Consumer:
                                               
    Lines of credit
    91,397       91,327       0       72,432       616       616  
    Other
    0       0       0       6,012       0       0  
    Credit card
    0       0       0       0       0       0  
Residential
    186,207       186,723       0       314,265       0       0  
            Subtotal
  $ 7,485,184     $ 7,472,654     $ 0     $ 7,682,023     $ 178,936     $ 163,473  
With an allowance recorded:
                                               
Commercial
  $ 1,339,105     $ 1,337,955     $ 466,001     $ 959,371     $ 30,124     $ 29,623  
Commercial Real Estate:
                                               
    General
    4,171,379       4,135,809       1,024,846       2,865,844       51,694       30,049  
    Construction
    2,275,662       2,275,337       1,287,550       2,069,800       2,373       2,202  
Consumer:
                                               
    Lines of credit
    63,854       63,675       16,128       145,132       11,143       3,682  
    Other
    119,449       119,275       93,181       74,854       1,955       1,650  
    Credit card
    0       0       0       1,006       0       0  
Residential
    409,391       408,244       103,393       699,853       22,948       18,135  
            Subtotal
  $ 8,378,840     $ 8,340,295     $ 2,991,099     $ 6,815,860     $ 120,237     $ 85,341  
Total
  $ 15,864,024     $ 15,812,949     $ 2,991,099     $ 14,497,883     $ 299,173     $ 248,814  

Non-performing loans and impaired loans are defined differently.  Some loans may be included in both categories, whereas other loans may only be included in one category.  However, non-accrual loans and loans past due 90 days still on accrual are all individually classified impaired loans.
 
 
-16-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

The following tables present the aging of the recorded investment in past due and non accrual loans by class of loans as of June 30, 2012:

               
Greater Than 90
   
Total Accruing
         
Total Recorded
 
   
30-59 Days Past
   
60-89 Days Past
   
Days Past
   
Past Due
   
Current
   
Investment of
 
Accruing Loans
 
Due
   
Due
   
Due
   
Loans
   
Accruing Loans
   
Accruing Loans
 
Commercial
  $ 16,426     $ 17,383     $ 0     $ 33,809     $ 41,212,376     $ 41,246,185  
Commercial Real Estate:
                                               
    General
    0       0       0       0       50,874,468       50,874,468  
    Construction
    0       0       0       0       3,954,219       3,954,219  
Consumer:
                                               
    Lines of credit
    0       0       0       0       12,112,758       12,112,758  
    Other
    5,350       0       0       5,350       2,102,350       2,107,700  
    Credit card
    2,538       0       0       2,538       520,686       523,224  
Residential
    0       7,261       0       7,261       16,255,919       16,263,180  
    Total
  $ 24,314     $ 24,644     $ 0     $ 48,958     $ 127,032,776     $ 127,081,734  

               
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
  $ 25,647     $ 12,596     $ 1,305,314     $ 1,343,557     $ 123,051     $ 1,466,608  
Commercial Real Estate:
                                               
    General
    158,995       0       89,975       248,970       1,686,478       1,935,448  
    Construction
    0       0       94,135       94,135       1,908,674       2,002,809  
Consumer:
                                               
    Lines of credit
    974       19,976       33,038       53,988       105,543       159,531  
    Other
    0       0       0       0       0       0  
    Credit card
    0       0       0       0       0       0  
Residential
    0       0       195,649       195,649       114,482       310,131  
    Total
  $ 185,616     $ 32,572     $ 1,718,111     $ 1,936,299     $ 3,938,228     $ 5,874,527  

 
-17-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

The following tables present the aging of the recorded investment in past due and non accrual loans by class of loans as of December 31, 2011:

               
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
  $ 576,736     $ 48,273     $ 0     $ 625,009     $ 48,278,897     $ 48,903,906  
Commercial Real Estate:
                                               
    General
    197,488       243,075       0       440,563       57,422,942       57,863,505  
    Construction
    0       0       0       0       4,063,776       4,063,776  
Consumer:
                                               
    Lines of credit
    11,052       102,760       21,002       134,814       13,194,317       13,329,131  
    Other
    8,817       0       0       8,817       2,306,281       2,315,098  
    Credit card
    0       0       5,899       5,899       521,959       527,858  
Residential
    80,952       0       0       80,952       16,772,293       16,853,245  
    Total
  $ 875,045     $ 394,108     $ 26,901     $ 1,296,054     $ 142,560,465     $ 143,856,519  

               
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     $ 2,478     $ 1,172,890     $ 1,175,368     $ 161,434     $ 1,336,802  
Commercial Real Estate:
                                               
    General
    0       0       869,398       869,398       1,673,895       2,543,293  
    Construction
    0       0       406,090       406,090       2,012,951       2,419,041  
Consumer:
                                               
    Lines of credit
    4,826       66,587       48,230       119,643       0       119,643  
    Other
    0       0       8,459       8,459       0       8,459  
    Credit card
    0       0       0       0       0       0  
Residential
    0       0       0       0       172,078       172,078  
    Total
  $ 4,826     $ 69,065     $ 2,505,067     $ 2,578,958     $ 4,020,358     $ 6,599,316  
 
 
-18-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
4.
ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

Troubled Debt Restructurings:

The Company has allocated $1,698,919 of specific reserves on $10,788,238 of loans to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2012 and $1,499,705 on $9,036,794 as of December 31, 2011. At June 30, 2012, the Company did not have any additional performing loans outstanding to those customers. As of December 31, 2011, there was $222,700 committed to one customer.

During the three and six month periods ending June 30, 2012, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a stated rate of interest lower than the current market rate for new debt with similar risk; interest only payments on an amortizing note; a reduced payment amount which does not fully cover the interest; or a permanent reduction of the recorded investment in the loan.

Modifications involving a stated interest rate of the loan below the current market rate were for periods ranging from 11 months to 5 years. Modifications involving a reduced payment amount were for periods ranging from 5 months to 4 years. Two modifications involved a permanent reduction of the recorded investment in the loan.

The following table presents loans by class modified as troubled debt restructurings that occurred during the three month period ending June 30, 2012:

         
Pre-Modification
   
Post-Modification
 
         
Outstanding Recorded
   
Outstanding Recorded
 
Three Months Ended June 30, 2012
 
Number of Loans
   
Investment
   
Investment
 
Troubled Debt Restructurings:
                 
Consumer:
                 
    Lines of credit
    1     $ 22,416     $ 22,416  
    Total
    1     $ 22,416     $ 22,416  

In the three month period ended June 30, 2012, there were no charge-offs as part of a troubled debt restructuring arrangement however an additional $22,000 of specific reserves were established on this troubled debt restructuring.
 
 
-19-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

The following table presents loans by class modified as troubled debt restructurings that occurred during the six month period ending June 30, 2012:

         
Pre-Modification
   
Post-Modification
 
         
Outstanding Recorded
   
Outstanding Recorded
 
Six Months Ended June 30, 2012
 
Number of Loans
   
Investment
   
Investment
 
Troubled Debt Restructurings:
                 
Commercial
    1     $ 11,880     $ 11,880  
Commercial Real Estate:
                       
    General
    5       3,446,269       2,808,146  
Consumer:
                       
    Lines of credit
    2       126,860       126,860  
Residential
    1       62,085       62,085  
    Total
    9     $ 3,647,094     $ 3,008,971  

In the six month period ended June 30, 2012, there were $638,000 of charge-offs as part of a troubled debt restructuring arrangement and an additional $50,000 of specific reserves were established on these troubled debt restructurings.

Generally, a modified loan is considered to be in payment default when the borrower is not performing according to the renegotiated terms and stops communicating and working with the Bank.

For the three and six month periods ending June 30, 2012, there were no troubled debt restructurings that experienced a payment default within twelve months following the modification.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed utilizing the Company’s internal underwriting policy.

 
-20-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
4.    ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

Credit Quality Indicators:

The Bank utilizes a numeric grading system for commercial and commercial real estate loans to indicate the strength of the credit. At origination, grades are assigned to each commercial and commercial real estate loan by assessing information about the specific borrower’s situation including cash flow analysis and the estimated collateral values. The loan grade is reassessed at each renewal or amendment but any credit may receive a review based on lender identification of changes in the situation or behavior of the borrower. All commercial and commercial real estate loans exceeding $500,000 are formally reviewed at least annually. Once a loan is graded a 5M or greater number, and is over $100,000, the loan grade will be reanalyzed once per quarter to assess the borrowers compliance with the Bank’s documented action plan. In addition to these methods for assigning loan grades, changes may occur through the external loan review or regulatory exam process. The loan grades are as follows:

1.  
Exceptional. Loans with an exceptional credit rating.
2.  
Quality. Loans with excellent sources of repayment that conform, in all respects, to Bank policy and regulatory requirements. These are loans for which little repayment risk has been identified.
3.  
Above Average. Loans with above average sources of repayment and minimal identified credit or collateral exceptions and minimal repayment risk.
4.  
Average. Loans with average sources of repayment that materially conform to Bank policy and regulatory requirements. Repayment risk is considered average.
5.  
Acceptable. Loans with acceptable sources of repayment and risk.
5M.  
Monitor. Loans considered to be below average quality. The loans are often fundamentally sound but require more frequent management review because of an adverse financial event. Risk of non payment is elevated.
6.  
Special Mention. Loans that have potential weaknesses and deserve close attention. If uncorrected, further deterioration is likely. Risk of non payment is above average.
7.  
Substandard. Loans that are inadequately protected by the borrower’s capacity to pay or the collateral pledged. Risk of non payment is high.
8.  
Doubtful. Loans in this grade have identified weaknesses that make full repayment highly questionable and improbable.

When a loan is downgraded to a nine, it is considered a loss and is charged-off.
 
 
-21-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
4.
ALLOWANCE FOR LOAN LOSSES AND IMPAIRED LOANS (Continued):

As of June 30, 2012 and December 31, 2011, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

           
Commercial Real Estate
   
Commercial Real Estate
 
     
Commercial
   
General
   
Construction
 
     
June 30,
   
December 31,
   
June 30,
   
December 31,
   
June 30,
   
December 31,
 
   
2012
   
2011
   
2012
   
2011
   
2012
   
2011
 
1     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0  
2       153,103       253,956       0       0       0       0  
3       4,318,440       4,947,905       3,130,994       3,141,880       0       0  
4       13,807,739       13,552,704       15,001,501       19,274,469       482,543       271,335  
5       15,267,636       21,119,918       21,574,774       21,250,749       2,021,190       2,347,947  
5 M     4,039,515       3,910,143       6,898,930       5,452,332       1,398,694       1,360,030  
6       357,724       1,838,505       3,825,853       7,562,147       0       0  
7       3,677,023       3,567,564       1,878,648       2,293,571       0       39,330  
8       1,091,613       1,050,013       499,216       1,431,650       2,054,601       2,464,175  
Total
  $ 42,712,793     $ 50,240,708     $ 52,809,916     $ 60,406,798     $ 5,957,028     $ 6,482,817  

The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses.  For residential and consumer loan classes, the Company evaluates credit quality based on the aging status of the loan, which was previously presented and by payment activity.  The following tables present the recorded investment in residential and consumer loans based on payment activity as of June 30, 2012 and December 31, 2011:

   
Residential
 
   
June 30,
   
December 31,
 
   
2012
 
2011
 
Performing
  $ 15,725,088     $ 16,429,725  
Impaired
    848,223       595,598  
Total
  $ 16,573,311     $ 17,025,323  

   
Consumer – Lines of credit
   
Consumer – Other
   
Consumer – Credit card
 
   
June 30,
   
December 31,
   
June 30,
   
December 31,
   
June 30,
   
December 31,
 
   
2012
   
2011
   
2012
   
2011
   
2012
   
2011
 
Performing
  $ 12,039,645     $ 13,293,523     $ 1,976,068     $ 2,204,108     $ 523,224     $ 527,858  
Impaired
    232,644       155,251       131,632       119,449       0       0  
Total
  $ 12,272,289     $ 13,448,774     $ 2,107,700     $ 2,323,557     $ 523,224     $ 527,858  
 
 
-22-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

5.  
FORECLOSED ASSETS
 
 
Foreclosed asset activity for the six months ended was as follows:

   
June 30,
   
June 30,
 
   
2012
 
2011
 
Beginning of year
  $ 3,276,838     $ 3,382,594  
Additions
    1,051,028       706,617  
Reductions from sales
    (786,442 )     (389,455 )
Direct write-downs
    (185,020 )     (392,928 )
End of period
  $ 3,356,404     $ 3,306,828  
 
               
Expenses related to foreclosed assets include:
               
Operating expenses, net of rental income
  $ 119,385     $ 59,290  
 
6.      PREMISES AND EQUIPMENT

Period end premises and equipment were as follows:

   
June 30,
   
December 31,
 
   
2012
 
2011
 
Land & land improvements
  $ 4,700,106     $ 5,466,281  
Buildings & building improvements
    6,132,163       6,132,163  
Furniture, fixtures and equipment
    3,690,566       3,679,037  
      14,522,835       15,277,481  
Less:  accumulated depreciation
    5,074,789       4,872,616  
    $ 9,448,046     $ 10,404,865  

During the second quarter of 2012, the Company sold land with a carrying value of $790,135 resulting in a gain on sale of $208,389.
 
 
-23-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7.  
DEPOSITS

The components of the outstanding deposit balances at June 30, 2012 and December 31, 2011 were as follows:

   
June 30,
   
December 31,
 
   
2012
 
2011
 
    Non-interest-bearing DDA
  $ 35,565,711     $ 33,281,198  
    Interest-bearing DDA
    21,387,359       19,432,618  
    Money market
    17,981,961       18,468,540  
    Savings
    9,545,451       8,477,893  
    Time, under $100,000
    89,023,531       95,211,768  
    Time, over $100,000
    10,114,195       16,673,219  
Total Deposits
  $ 183,618,208     $ 191,545,236  

There were no brokered deposits at June 30, 2012 and $3,462,000 at December 31, 2011. Since the Bank was not categorized as “well capitalized” at June 30, 2012 and is under a Consent Order, a regulatory waiver is required to accept, renew or rollover brokered deposits. The Bank has not issued brokered deposits since January of 2010.

8.
SHORT-TERM BORROWINGS

The Company’s short-term borrowings consist of repurchase agreements and less frequently borrowings from the FRB Discount Window. There have been no borrowings from the FRB Discount Window since January 2010. The June 30, 2012 and December 31, 2011 short-term borrowing information was as follows:

   
Repurchase
 
   
Agreements
 
       
Outstanding at June 30, 2012
  $ 10,993,728  
    Average interest rate at period end
    0.72 %
    Average balance during period
    10,199,796  
    Average interest rate during period
    0.77 %
    Maximum month end balance during period
    12,037,087  
         
Outstanding at December 31, 2011
  $ 7,814,745  
    Average interest rate at year-end
    0.71 %
    Average balance during year
    9,626,125  
    Average interest rate during year
    0.76 %
    Maximum month end balance during year
    11,986,254  
 
 
-24-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9.
FEDERAL HOME LOAN BANK BORROWINGS:

The Bank is a member of the Federal Home Loan Bank of Indianapolis.  Based on its current Federal Home Loan Bank Stock holdings and collateral, the Bank has the capacity to borrow $2,960,077. Each borrowing requires a direct pledge of securities or loans or both. To support potential borrowings with the Federal Home Loan Bank, the Bank had residential loans with a fair market value of $3,700,096 pledged at June 30, 2012. The Bank had no outstanding borrowings with the Federal Home Loan Bank at either June 30, 2012 or December 31, 2011.

10.
SUBORDINATED DEBENTURES

The Trust, a business trust formed by the Company, sold 4,500 Cumulative Preferred Securities (“trust preferred securities”) at $1,000 per security in a December 2004 offering. The proceeds from the sale of the trust preferred securities were used by the Trust to purchase an equivalent amount of subordinated debentures from the Company. The trust preferred securities and subordinated debentures carry a floating rate of 2.05% over the 3-month LIBOR and was 2.51% at June 30, 2012 and 2.63% at December 31, 2011. The stated maturity is December 30, 2034. The trust preferred securities are redeemable at par on any interest payment date and are, in effect, guaranteed by the Company. Interest on the subordinated debentures are payable quarterly on March 30th, June 30th, September 30th and December 30th. The Company is not considered the primary beneficiary of the Trust (variable interest entity), therefore the Trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability, and the interest expense is recorded on the Company’s consolidated statement of income.

The terms of the subordinated debentures, the trust preferred securities and the agreements under which they were issued, give the Company the right, from time to time, to defer payment of interest for up to 20 consecutive quarters, unless certain specified events of default have occurred and are continuing.  The deferral of interest payments on the subordinated debentures results in the deferral of distributions on the trust preferred securities. In May 2010, the Company exercised its option to defer regularly scheduled quarterly interest payments beginning with the quarterly interest payment that was scheduled to be paid on June 30, 2010. The Company’s deferral of interest does not constitute an event of default.

During the deferral period, interest will continue to accrue on the subordinated debentures.  Also, the deferred interest will accrue interest.  At the expiration of the deferral period, all accrued and unpaid interest will be due and payable and a corresponding amount of distributions will be payable on the trust preferred securities.

The indenture under which the subordinated debentures were issued prohibits certain actions by the Company during the deferral period.  Among other things, and subject to certain exceptions, during the deferral period, the Company is prohibited from declaring or paying any dividends or distributions on, or redeeming, purchasing, acquiring or making any liquidation payment with respect to, any shares of its capital stock.  Although the Company has not determined the duration of the deferral period, as of December 16, 2010, under the FRB Written Agreement, the Company is prohibited from making any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior FRB approval. At June 30, 2012, the accrued interest payable on the subordinated debentures was $264,129.
 
 
-25-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
11. 
NOTES PAYABLE

On January 3, 2011, the Company’s $5,000,000 term loan with Fifth Third Bank (“Fifth Third”) matured. The loan is in default, and the Company does not have the resources to pay the outstanding principal and accrued interest and does not expect to have it in the near future. Under the terms of the note, Fifth Third has the right to foreclose on the Bank’s stock which collateralizes the loan. As of June 30, 2012, Fifth Third has not taken any foreclosure action or communicated intent to do so. The Company continues to accrue interest at the rate of the term loan at maturity and after which is 6.00%, 275 basis points above Fifth Third’s prime rate. On June 30, 2012, there was $609,000 of unpaid interest compared to $458,000 at December 31, 2011.
 
12.
COMMITMENTS AND OFF-BALANCE SHEET RISK

Some financial instruments are used to meet financing needs and to reduce exposure to interest rate changes.  These financial instruments include commitments to extend credit and standby letters of credit.  These involve, to varying degrees, credit and interest-rate risk in excess of the amount reported in the financial statements. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment, and generally have fixed expiration dates.  Standby letters of credit are conditional commitments to guarantee a customer’s performance to another party.  Exposure to credit loss, if the customer does not perform, is represented by the contractual amount for commitments to extend credit and standby letters of credit.  Collateral or other security is normally obtained for these financial instruments prior to their use and many of the commitments are expected to expire without being used.

A summary of the notional and contractual amounts of outstanding financing instruments with off-balance-sheet risk as of June 30, 2012 and December 31, 2011 follows:

   
June 30, 2012
 
December 31, 2011
 
             
 Unused lines of credit and letters of credit
  $ 20,687,736     $ 22,611,655  
 Commitments to make loans
    118,375       0  

Commitments to make loans generally terminate one year or less from the date of commitment and may require a fee.  Since many of the above commitments on lines of credit and letters of credit expire without being used, the above amounts related to those categories do not necessarily represent future cash disbursements.

13. 
FAIR VALUE MEASUREMENTS

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

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
 
 
-26-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13.  
FAIR VALUE MEASUREMENTS (Continued)

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

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

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

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

Servicing Rights: The fair value of SBA servicing rights is obtained from a third party using assumptions provided by the Company. The individual servicing rights are valued individually taking into consideration the original term to maturity, the current age of the loan and the remaining term to maturity. Their valuation methodology utilized for the servicing rights begins with projecting future cash flows for each servicing asset, based on its unique characteristics and market-based assumptions for prepayment speeds. The present value of the future cash flows are then calculated utilizing a market-based discount rate assumption. These inputs are generally observable in the marketplace resulting in a Level 2 classification.

Impaired Loans:  The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals or internal evaluations. Management usually adds 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.

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 usually adds 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.
 
 
-27-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
13.
FAIR VALUE MEASUREMENTS (Continued)

Assets measured at fair value on a recurring basis are summarized below as of the periods ended June 30, 2012 and December 31, 2011:

         
Fair Value Measurements Using
 
         
Quoted Prices
   
Significant
       
         
in Active
   
Other
   
Significant
 
         
Markets for
   
Observable
   
Unobservable
 
         
Identical Assets
   
Inputs
   
Inputs
 
June 30, 2012
 
Total
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Available for sale securities:
                       
    US Treasury
  $ 5,603,515     $ 5,603,515     $ 0     $ 0  
    US Government and
                               
      federal agency
    18,781,514       0       18,781,514       0  
    Municipals
    2,363,907       0       2,363,907       0  
    Mortgage-backed and
                               
      collateralized mortgage
                               
      obligations– residential
    10,132,778       0       10,132,778       0  
        Total
  $ 36,881,714     $ 5,603,515     $ 31,278,199     $ 0  
                                 
Servicing assets
  $ 41,324     $ 0     $ 41,324     $ 0  
                                 
December 31, 2011
                               
Available for sale securities:
                               
    US Treasury
  $ 4,067,656     $ 4,067,656     $ 0     $ 0  
    US Government and
                               
      federal agency
    15,572,588       0       15,572,588       0  
    Municipals
    2,891,420       0       2,891,420       0  
    Mortgage-backed and
                               
      collateralized mortgage
                               
      obligations– residential
    12,040,439       0       12,040,439       0  
        Total
  $ 34,572,103     $ 4,067,656     $ 30,504,447     $ 0  
                                 
Servicing assets
  $ 76,276     $ 0     $ 76,276     $ 0  

There were no transfers between levels during the first six months of 2012 or the three month periods ended June 30, 2012 or 2011.  During the first quarter of 2011, there was a transfer of two federal agency securities with a fair value of $991,568 at March 31, 2011 from Level 1 to Level 2.

 
-28-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13.
FAIR VALUE MEASUREMENTS (Continued)

Assets measured at fair value on a non-recurring basis are summarized below as of the periods ended June 30, 2012 and December 31, 2011.  Impaired loans and foreclosed assets are included if the fair value of such assets was revised during the quarterly period then ended.
 
         
Significant
 
         
Unobservable Inputs
 
   
Total
 
(Level 3)
 
June 30, 2012
           
Impaired loans:
           
    Commercial
  $ 284,037     $ 284,037  
    Commercial Real Estate:
               
      General
    0       0  
      Construction
    91,835       91,835  
    Consumer:
               
      Lines of credit
    374       374  
      Other
    97       97  
    Residential
    388,606       388,606  
      Total
  $ 764,949     $ 764,949  
Foreclosed assets:
               
    Commercial Real Estate:
               
      General
  $ 1,319,449     $ 1,319,449  
    Residential
    73,238       73,238  
      Total
  $ 1,392,687     $ 1,392,687  
                 
December 31, 2011
               
Impaired loans:
               
    Commercial
  $ 19,686     $ 19,686  
    Commercial Real Estate:
               
      General
    3,871,595       3,871,595  
      Construction
    160,276       160,276  
    Consumer:
               
      Lines of credit
    48,269       48,269  
      Other
    0       0  
    Residential
    198,244       198,244  
      Total
  $ 4,298,070     $ 4,298,070  
Foreclosed assets:
               
    Commercial Real Estate:
               
      General
  $ 570,069     $ 570,069  
      Construction
    6,160       6,160  
    Residential
    204,668       204,668  
      Total
  $ 780,897     $ 780,897  

As discussed previously, the Bank generally utilizes real estate appraisals or internal evaluations for the valuation of its impaired loans and foreclosed assets.  These valuations use either a comparable sales or income approach.  Adjustments are routinely made in the appraisal process by the appraisers to account for differences between the comparable sales and income data available. These adjustments can vary from 0 to 40% depending on the property type as well as various sales and property characteristics including but not limited to: date of sale, size and condition of facility, quality of construction and proximity to the subject property. Further unobservable inputs used in estimating fair value are
 
 
-29-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
13.
FAIR VALUE MEASUREMENTS (Continued)

additional discounts to the appraised value to consider: 1) selling costs where discounts can range from 2 to 15% and 2) the age of the appraisal with discounts ranging from 10 to 30%.

The following table presents information as of June 30, 2012 about significant unobservable inputs related to the Bank’s individually material Level 3 financial assets, by class, measured on a nonrecurring basis:
 
       
Valuation
Significant Unobservable
 
Range
   
Weighted
 
   
Fair Value
 
Technique (s)
Inputs
 
of Inputs
   
Average
 
June 30, 2012
                     
   Foreclosed assets:
                     
Commercial Real Estate:
                     
         
Adjustments for differences between
           
      General
  $ 773,919  
Sales comparison approach
the comparable sales
    (50.0 ) - 9.4%     (26.4 )%
           
Adjustments for differences in net
               
         
Income approach
operating income expectations
    10.0 %     10.0 %
Total
  $ 773,919                      

There were no individually material impaired loans marked to fair value during the quarterly period ended June 30, 2012.

The following two paragraphs describe the impairment charges recognized during the period:

The method used to determine the valuation of impaired loans depends on the anticipated source of repayment. Most of the Bank’s impaired loans are collateral dependent; only two impairments are measured using the cash flow method. Collateral dependent impaired loans are measured using the fair value of the collateral. At June 30, 2012, such impaired loans had a recorded investment of $6,638,184, with a valuation allowance of $2,429,453 compared to impaired loans with a recorded investment of $7,528,841 and a valuation allowance of $2,902,547 at December 31, 2011. The fair value of the collateral on the collateral dependent loans was determined using independent appraisals or internal evaluations and was adjusted for anticipated disposition costs. Increases to specific allocations on impaired, collateral dependent loans were $600,000 for the first six months of 2012. However, in total, the impact to the provision for loan losses from impaired, collateral dependent loans was $(473,000) for the six month period ended June 30, 2012.

At June 30, 2012 and December 31, 2011, foreclosed assets carried a fair value of $3,341,237 and $3,261,671 respectively. During the six month period ended June 30, 2012, eighteen properties included in this total were written down by $185,020. There were also eight properties totaling $1,051,028 (at fair value) added to other real estate owned during the first six months of 2012. The fair value of other real estate owned was determined primarily using independent appraisals or internal evaluations and was adjusted for anticipated disposition costs.
 
 
-30-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
13.
FAIR VALUE MEASUREMENTS (Continued)

The carrying amounts and estimated fair values of financial instruments not previously presented above are as follows:

         
Fair Value Measurements
   
December 31,
 
         
at June 30, 2012 Using
   
2011
 
   
Carrying
                           
Carrying
   
Fair
 
   
Amount
   
Level 1
   
Level 2
   
Level 3
   
Total
   
Amount
   
Value
 
   
(in thousands)
 
Financial assets
                                         
    Cash and cash equivalents
  $ 18,444     $ 18,444     $ 0     $ 0     $ 18,444     $ 8,920     $ 8,920  
    Loans held for sale
    6,070       0       6,224       0       6,224       5,535       5,940  
    Loans, net (including impaired)
    128,053       0       0       123,027       123,027       144,359       139,176  
    FHLB stock
    451       N/A       N/A       N/A       N/A       451       N/A  
    Accrued interest receivable
    649       18       160       471       649       746       746  
                                                         
Financial liabilities
                                                       
    Deposits
    183,618       83,705       99,977       0       183,682       191,545       193,775  
    Federal funds purchased and
                                                       
      repurchase agreements
    10,994       0       10,994       0       10,994       7,815       7,815  
    Subordinated debentures
    4,500       0       0       1,125       1,125       4,500       1,125  
    Notes payable
    5,000       0       0       900       900       5,000       500  
    Accrued interest payable
    946       5       68       66       139       738       130  

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.

 
-31-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13.   FAIR VALUE MEASUREMENTS (Continued)

(d) Deposits

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(e) Federal funds purchased and repurchase agreements

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

(f) Subordinated debentures and Notes payable

The fair values of the Company’s subordinated debentures and notes payable are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements and consideration of the Company’s liquidity, resulting in a Level 3 classification.

(g) Accrued interest receivable/payable
 
 
The carrying amounts of accrued interest approximate fair value resulting in a Level 1, 2 or 3 classification, depending on the associated asset or liability.

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


14.
INCOME TAXES

Accounting guidance related to income taxes requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard.  In making such judgments, we consider both positive and negative evidence and analyze changes in near-term market conditions as well as other factors which may impact future operating results. Significant weight is given to evidence that can be objectively verified.  The continuing recent losses resulting from the distressed operating environment in Michigan have significantly restricted our ability under the accounting rules to rely on projections of future taxable income to support the recovery of our deferred tax assets. Consequently, we determined it necessary to carry a valuation allowance against our entire net deferred tax asset.  The valuation allowance against our deferred tax assets may be reversed to income in future periods to the extent that the related deferred income tax assets are realized or the valuation allowance is otherwise no longer required.  We will continue to monitor our deferred tax assets quarterly for changes affecting their realizability.
 
 
-32-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
15.
REGULATORY MATTERS

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

Prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If a bank is not well capitalized, regulatory approval is required to accept brokered deposits.  Subject to limited exceptions, a bank may not make a capital distribution if, after making the distribution, it would be undercapitalized.  If a bank is undercapitalized, it is subject to being closely monitored by its principal federal regulator, its asset growth and expansion are restricted, acquisitions, new activities, new branches, payment of dividends or management fees are prohibited and plans for capital restoration are required. In addition, further specific types of restrictions may be imposed on the bank at the discretion of the federal regulator. The Bank was in the undercapitalized category at both June 30, 2012 and December 31, 2011.
 
 
-33-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
15.
REGULATORY MATTERS (Continued)

Actual capital amounts and ratios for the Bank and required capital amounts and ratios for the Bank to be adequately capitalized and to be at the level mandated by the Consent Order at June 30, 2012 and December 31, 2011 were:

               
Minimum Required
   
Minimum Required
 
               
For Capital
   
Under
 
   
Actual
   
Adequacy Purposes
   
Consent Order
 
   
Amount
 
Ratio
   
Amount
 
Ratio
   
Amount
 
Ratio
 
                                     
June 30, 2012
                                   
Total Capital (Tier 1 and
                                   
Tier 2) to risk-weighted
                                   
    assets of the Bank
  $ 10,600,266       7.40 %   $ 11,466,326       8.00 %   $ 15,766,199       11.00 %
Tier 1 (Core) Capital
                                               
    to risk-weighted
                                               
    assets of the Bank
    8,777,421       6.12       5,733,163       4.00       N/A       N/A  
Tier 1 (Core) Capital
                                               
    to average assets
                                               
    of the Bank
    8,777,421       4.20       8,366,877       4.00       17,779,614       8.50  

               
Minimum Required
   
Minimum Required
 
               
For Capital
   
Under
 
   
Actual
   
Adequacy Purposes
   
Consent Order
 
   
Amount
 
Ratio
   
Amount
 
Ratio
   
Amount
 
Ratio
 
                                     
December 31, 2011
                                   
Total Capital (Tier 1 and
                                   
Tier 2) to risk-weighted
                                   
    assets of the Bank
  $ 10,350,300       6.40 %   $ 12,944,731       8.00 %   $ 17,799,005       11.00 %
Tier 1 (Core) Capital
                                               
    to risk-weighted
                                               
    assets of the Bank
    8,287,231       5.12       6,472,366       4.00       N/A       N/A  
Tier 1 (Core) Capital
                                               
    to average assets
                                               
    of the Bank
    8,287,231       3.79       8,756,307       4.00       18,607,152       8.50  

Federal Reserve guidelines limit the amount of allowance for loan losses that can be included in Tier 2 capital. In general only 1.25% of net risk-weighted assets are allowed to be included. At June 30, 2012, only $1,822,844 was counted as Tier 2 capital and $2,498,453 was disallowed.  At December 31, 2011, $2,063,069 was counted as Tier 2 capital and $3,236,385 was disallowed.

 
-34-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
15.
REGULATORY MATTERS (Continued)

The Bank’s Consent Order with the FDIC and the OFIR, its primary banking regulators, became effective on September 2, 2010. The Bank agreed to the terms of the Consent Order without admitting or denying any charge of unsafe or unsound banking practices relating to capital, asset quality, or earnings. The Consent Order imposes no fines or penalties on the Bank. The Consent Order will remain in effect and enforceable until it is modified, terminated, suspended, or set aside by the FDIC and OFIR.

The Consent Order required the Bank to implement a written profit plan, a written contingency funding plan, a written plan to reduce the Bank's reliance on brokered deposits, a comprehensive strategic plan; and to develop an analysis and assessment of the Bank's management needs.  Under the Consent Order, the Bank is required to maintain higher capital levels than requested under prompt corrective action and the Bank may not declare or pay any dividend without the prior written consent of the regulators.

Prior to the issuance of the Consent Order, the Bank's Board of Directors and management had already commenced initiatives and strategies to address a number of the requirements of the Consent Order. The Bank continues to work in cooperation with its regulators.  Our ability to fully comply with all of the requirements of the Consent Order, including maintaining specified capital levels, is not entirely within our control, and is not assured. Our ability to comply with the requirements of the Consent Order may be affected by many factors, including the availability of capital and other funds, the extent of repayment of loans by borrowers, declines in the value of collateral including real estate, the Bank's ability to realize on collateral, actions that may be taken by our lender in connection with our matured $5,000,000 term loan and actions by bank regulators. Failure to comply with provisions of the Consent Order may result in further regulatory action that could have a material adverse effect on us and our shareholders, as well as the Bank.

There were several directives related to loans contained in the Consent Order. All action plans have been submitted to the FDIC. Management continues to update the action plans and is working diligently to reduce the risk position as outlined in each action plan.
 
Under the Consent Order the Bank was required, within 90 days of September 2, 2010, to have and maintain its level of tier one capital, as a percentage of its total assets, at a minimum of 8.5%, and its level of qualifying total capital, as a percentage of risk-weighted assets, at a minimum of 11%. The Bank was not in compliance with this requirement at June 30, 2012 or either December 31, 2010 or 2011. Management continues to explore options to raise the capital required for full compliance. At June 30, 2012, a capital contribution of $9,002,000 would have been needed to meet the capital ratios specified in the Consent Order.

Under the Consent Order the Bank is restricted from declaring or paying dividends without prior written authorization of the FDIC. The Bank is in full compliance with this restriction.

As required by the Consent Order, the Bank adopted a detailed liquidity plan on November 17, 2010 which provided for intended liquidity sources to meet the Bank’s assessed liquidity needs over the time horizons of 6, 12 and 18 months.  As a condition of the Consent Order, the Bank is unable to accept brokered deposits.

 
-35-

 
COMMUNITY SHORES BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15.
REGULATORY MATTERS (Continued)

Since the beginning of 2010, the Bank has been able to replace maturing brokered deposits with local deposits, including internet based time deposits and core deposits. Management does not believe the restriction on issuing brokered deposits imposes a significant liquidity problem for the Bank. There were no brokered deposit balances at June 30, 2012.

On August 17, 2011, the Bank was issued a Supervisory Prompt Corrective Action Directive (the “Directive”) because of its undercapitalized capital category at December 31, 2010, its failure to submit a capital restoration plan that satisfies the requirements spelled out in the FDIC Rules and Regulations, and the continued deterioration of the Bank. The Directive stipulated that the Bank be restored to an “adequately capitalized” capital category within 60 days of the issuance of the
Directive. Since the issuance of the Consent Order, the board has made many efforts to secure funding and comply with both the Consent Order and the Directive but has not been successful. As such, the Bank was not in compliance with the Directive at the end of 60 days and remains out of compliance. The board informed the FDIC in a letter dated October 14, 2011 that it was unable to comply with the Directive. There has been no further communications with the FDIC regarding the Directive. The board’s efforts to garner capital for the Bank are continuing.


 
-36-

 
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The discussion below details the financial results of the Company and its wholly owned subsidiaries, the Bank and Community Shores Financial Services, and the Bank’s subsidiary, the Mortgage Company, and Berryfield, the Mortgage Company’s subsidiary, through June 30, 2012 and is separated into two parts which are labeled Financial Condition and Results of Operations. The part labeled Financial Condition compares the financial condition at June 30, 2012 to that at December 31, 2011. The part labeled Results of Operations discusses the three and six month periods ending June 30, 2012 as compared to the same periods of 2011. Both parts should be read in conjunction with the interim consolidated financial statements and footnotes included in Item 1 of Part I of this Form 10-Q.

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

Future Factors include, among others, changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulation or actions by bank regulators; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; changes in the national and local economy; the ability of the Company to borrow money or raise additional capital to maintain or increase its or the Bank’s capital position or when desired to support future growth; action that Fifth Third may take in connection with its $5.0 million term loan to the Company, the repayment of which is now in default; lack of adequate cash by the Company to continue its business or pay its debts; failure to comply with provisions of the Consent Order, Written Agreement or Directive may result in further regulatory action that could have a material adverse effect on us and our shareholders, as well as the Bank; and other factors, including risk factors, referred to from time to time in filings made by the Company with the Securities and Exchange Commission.  These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement. These risks and uncertainties should be considered when evaluating forward-looking statements. Undue reliance should not be placed on such statements.
 
 
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The overall economic environment remains challenging but appears to be stabilizing, both nationally and locally. Unemployment in Muskegon and Ottawa counties is declining but remains at a serious level. At June 30, 2012, unemployment was 8.7% for Muskegon County and 7.2% for Ottawa County. Additionally, property values, although low, are steadying which should lead to improved sales and construction activity. Although the current outlook is more optimistic, the effects of the extended downturn had a negative effect on the financial health of the Bank. Poor earnings stemming primarily from deteriorating asset quality eroded the Bank’s capital ratios subjecting it to additional regulatory scrutiny.

On September 2, 2010, the Bank entered into a Consent Order with the Federal Deposit Insurance Corporation (“FDIC”) and the State of Michigan’s Office of Financial and Insurance Regulation (“OFIR”), its primary regulators. The Bank agreed to the terms of the Consent Order without admitting or denying any charge of unsafe or unsound banking practices relating to capital, asset quality, or earnings. The Consent Order imposes no fines or penalties on the Bank. The Consent Order will remain in effect and enforceable until it is modified, terminated, suspended, or set aside by the FDIC and OFIR. Under the Consent Order the Bank was required, within 90 days of September 2, 2010, to have and maintain its level of Tier 1 capital, as a percentage of its total assets, at a minimum of 8.5%, and its level of qualifying total capital, as a percentage of risk-weighted assets, at a minimum of 11%. The Bank was not able to meet these requirements within the required 90-day period and remains out of compliance with the Consent Order as of June 30, 2012.

The lack of financial soundness of the Bank and the Company’s inability to serve as a source of strength for the Bank resulted in the board of directors entering into a Written Agreement with the Federal Reserve Bank of Chicago (the “FRB”), the Company’s primary regulator. The Written Agreement became effective on December 16, 2010, when it was executed by the FRB. The Written Agreement provides that: (i) the Company must take appropriate steps to fully utilize its financial and managerial resources to serve as a source of strength to the Bank; (ii) the Company may not declare or pay any dividends or take dividends or any other payment representing a reduction in capital from the Bank or make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior FRB approval; (iii) the Company may not incur, increase or guarantee any debt or purchase or redeem any shares of its stock without prior FRB approval; (iv) the Company must submit a written statement of its planned sources and uses of cash for debt service, operating expenses and other purposes to the FRB within 30 days of the Written Agreement; (v) the Company shall take all necessary actions to ensure that the Bank, the Company and all nonbank subsidiaries of both the Bank and the Company comply with sections 23A and 23B of the Federal Reserve Act and Regulation W of the Board of Governors (12 C.F.R. Part 223) in all transactions between affiliates; (vi) the Company may not appoint any new director or senior executive officer, or change the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position, without prior regulatory approval; and finally (vii) within 30 days after the end of each calendar quarter following the date of the Written Agreement, the board of directors shall submit to the FRB written progress reports detailing the form and manner of all actions taken to secure compliance with the provisions of the Written Agreement as well as current copies of the parent company only financial statements. The Company has not yet been able to meet the obligation detailed in part (i) above; as the Company currently has negative equity and limited resources with which to support the capital needs of the Bank.
 
 
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Company’s main liquidity resource is its cash account balance which, as of June 30, 2012, was approximately $37,000. At this time, the Company has chosen to postpone the decision to take advantage of the Jumpstart Our Business Startups Act (the “JOBS Act”) and deregister as a public company. Management and the Board of Directors are considering many options for obtaining funding for the Company and do not believe it would be in the best interest of the Company to limit its options by deregistering. It is projected that the level of cash held at June 30, 2012 is adequate to support the Company’s overhead expenses through year-end 2012.

On January 3, 2011, the Company was not able to repay its $5 million term loan when it came due. The Company does not have the resources to pay the outstanding principal and does not expect to have it in the near future. The Company did not make the last nine contractual quarterly interest payments. The total interest due to Fifth Third at year-end 2011 was $458,000. The Company continues to accrue interest on the term loan and at June 30, 2012, the total interest due Fifth Third was $609,000. Since the Company presently does not have sufficient funds to pay off the term loan’s principal and accrued interest, Fifth Third has a right to foreclose on the Bank’s stock which collateralizes the term loan.

On August 17, 2011, the Bank was issued a Supervisory Prompt Corrective Action Directive (the “Directive”) because of its undercapitalized capital category at December 31, 2010, its failure to submit a capital restoration plan that satisfies the requirements stipulated in the FDIC Rules and Regulations, and the continued deterioration of the Bank. The Directive stipulated that the Bank be restored to an “adequately capitalized” capital category within 60 days of the issuance of the Directive. During the 60 days, the board made efforts to secure funding and comply with the Directive but was not successful. As such, the Bank was not in compliance with the Directive at the end of 60 days and remains out of compliance. The board informed the FDIC in a letter dated October 14, 2011 that it was unable to comply with the Directive. There has been no further communications with the FDIC regarding the Directive. The board’s efforts to garner capital for the Bank are expected to continue.

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

The Company’s net losses, failure to repay its term loan at maturity, non-compliance with the higher capital ratios of the Directive and the Consent Order, and the provisions of the Written Agreement raise substantial doubt about the Company’s ability to continue as a going concern. As a result of this substantial doubt, our auditors added an explanatory paragraph to their opinion on the Company’s December 31, 2011 and 2010 consolidated financial statements expressing substantial doubt about the Company’s ability to continue as a going concern. These financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

FINANCIAL CONDITION

Total assets decreased by $4.3 million to $204.3 million at June 30, 2012 from $208.6 million at December 31, 2011. This is a 2.1% decrease in assets during the first six months of 2012. The reduction in the balance sheet was primarily evidenced by a decline in the loan portfolio which increased the cash held in interest bearing bank accounts and reduced the need to replace maturing time deposits.
 
 
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cash and cash equivalents increased by $9.5 million to $18.4 million at June 30, 2012 from $8.9 million at December 31, 2011. Balances kept at the FRB increased $8.8 million since year-end 2011. The increase in liquidity is driven largely by the reduction in loan balances in the first six months of the year. Currently, the FRB balance is higher than the desired balance of between $7 and $10 million. Although excess liquidity is a conservative posture, it is harmful to earnings. Management discusses the Bank’s liquidity position regularly and attempts to balance expected cash flow needs while also planning for unexpected liquidity events. Many of the loan repayments were not expected. As a result, there have been fewer solicitations of time deposits from the internet.

The Bank’s security portfolio was $36.9 million at June 30, 2012 and $34.6 million at December 31, 2011. Investment activity in the first six months of the year included purchases of $7.3 million and maturities, pre-payments and calls of $4.5 million. In the first quarter of 2012, one security was sold for a gain of approximately $3,000.

The securities portfolio is a key source of liquidity for the Bank. Given the Bank’s troubled condition there are very few opportunities to secure off-balance-sheet borrowing facilities. Maintaining the unencumbered portion of the Bank’s security portfolio at a level that exceeds its general internal policy is critical and is one of the driving forces behind investment activity. Prior to the Consent Order, the Bank strived to have between 10% and 20% of its investment portfolio unpledged but given the lack of other liquidity resources, the Bank has chosen to maintain a higher level of unpledged investments. At June 30, 2012, 32% of the investment portfolio was unencumbered; this outcome is similar to the 33% that was unpledged on December 31, 2011.

At June 30, 2012, $25.0 million of securities were pledged to public fund customers, the Federal Reserve Discount Window (“Discount Window”) and customer repurchase agreements.

The quality of the investment portfolio has received much scrutiny over the past several years. The plight of the U.S. bond market and U.S. economy in general as well as the European debt crisis have all either directly or indirectly affected security market values. Regardless, the investment portfolio remains strong with an unrealized net gain of $661,000. Included in this total are unrealized losses of only approximately $15,000. At June 30, 2012, there were seven securities with an amortized cost of $3.2 million having an unrealized loss. Only one of the seven had an unrealized loss longer than 12 months. At year-end 2011, there were seven securities with an amortized cost of $4.1 million having an unrealized loss and two with an unrealized loss longer than 12 months.

At June 30, 2012, the Bank conducted its standard review for other-than-temporary impairment (“OTTI”). The unrealized losses referenced above were not determined to be other-than-temporary given the fact that the decline in value is less than 1%, that they are all fully guaranteed by the U.S. government, and the fact that the Bank has the ability and intent to hold them, and it is not likely the Bank will be required to sell the securities prior to them either recovering or maturing. The portfolio will continue to be reviewed for impairment in accordance with the Bank’s investment policy.

Loans held for sale activity during the first six months of 2012 included $6.4 million of loan originations and $5.9 million of loan sales. The associated gain on the loan sales was $103,000.
 
 
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Total loans (held for investment) decreased $17.3 million and were $132.4 million at June 30, 2012 down from $149.7 million at December 31, 2011. The decrease in the commercial and commercial real estate loan portfolios comprised 90% of the overall decline. The overall decrease in the loan portfolio did not substantially change the concentration. At June 30, 2012 the concentration of commercial and commercial real estate loans was 76%; down slightly from a level of 78% at year-end 2011.  The wholesale focus of the Bank has remained since opening in 1999. During the economic crisis, the credit quality of those borrowers in the two largest portfolio segments deteriorated the most and caused a significant increase in the Bank’s overall risk profile.

To help mitigate the credit risk, the Bank continues to develop and educate lenders and credit staff, and to invest time into the design and overall strengthening of the Company’s credit risk assessment processes. Simply put credit risk is the risk of borrower nonpayment typically on loans although it can be applicable to the investment portfolio as well. In both cases, avoiding portfolio concentrations in any one type of credit or in a specific industry helps to decrease risk; however, the risk of nonpayment for any reason exists with respect to all loans and investments. The Bank recognizes that credit losses will be experienced and will vary with, among other things, general economic conditions; the creditworthiness of the borrower over the term of the debt; and in the case of a collateralized loan, the quality of the collateral.

There is a very detailed process that has been developed and implemented by the Bank to estimate credit risk. The process is discussed at length in Note 1 to the Company’s December 31, 2011 financial statements. At each period end, the balance in the allowance for loan losses is based on management’s estimation of probable incurred credit losses utilizing the specified process. Basically, the analysis of the allowance for loan losses is comprised of two portions: general credit allocations and specific credit allocations. General credit allocations are made to various categories of loans based on loan ratings, delinquency trends, historical loss experience as well as current economic conditions. The specific credit allocation includes a detailed review of a borrower and its entire relationship resulting in an allocation being made to the allowance for that particular borrower.  A loan becomes specifically identified when, based on current information and events related to that particular borrower, it is probable that the Company will be unable to collect the scheduled payments of principal and interest according to the contractual terms of the loan agreement.

The allowance for loan losses is adjusted accordingly to maintain an adequate level based on the conclusion of the general and specific analysis. There are occasions when a specifically identified loan requires no allocated allowance for loan losses. To have no allocated allowance for loan loss, a specifically identified loan must be well secured and have a collateral analysis that supports a loan loss reserve allocation of zero.

At June 30, 2012, the allowance for loan losses totaled $4.3 million. During the first six months of 2012, $75,000 was added to the allowance through the provision expense. At year-end 2011, the allowance for loan losses was $5.3 million. The reduction in the allowance for loan losses is mostly related to net charge offs of $1.1 million occurring in the first half of 2012. The ratio of allowance to gross loans outstanding decreased to a level of 3.26% at June 30, 2012 compared to 3.54% at year-end 2011. Nearly $790,000 of the loan charge-offs occurring in the first six months of 2012 held specific allocations at year-end 2011.

 
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


The allocation of the allowance at June 30, 2012 and December 31, 2011 was as follows:

   
June 30, 2012
   
December 31, 2011
 
         
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
  $ 1,356,903       32.1 %   $ 1,309,632       33.4 %
    Commercial Real Estate
    2,251,981       44.1       3,386,433       44.4  
    Consumer
    442,467       11.3       410,001       10.9  
    Residential
    193,706       12.5       193,388       11.3  
    Unallocated
    76,240     N/A       0     N/A  
Total
  $ 4,321,297     100 %   $ 5,299,454     100 %

The general component of the allowance for loan losses as a percentage of non-specifically identified loans was 1.45% at June 30, 2012, a decrease of 27 basis points from year-end 2011.  At year-end 2011, the general component of the allowance for loan losses was 1.72% of total non-specifically identified loans. There is $76,000 of unallocated reserves in the allowance for loan losses. If these unallocated reserves were included in the general component at June 30, 2012, the ratio of reserves to non-specifically identified loans would increase to 1.52%. Management feels that the trend of the general component of the allowance for loan losses is in line with improvement in the economy, local unemployment, and risk in the portfolio including a reduction in both delinquency and charge-offs.

At June 30, 2012, the allowance contained $2,516,000 in specific allocations for impaired loans whereas at December 31, 2011 there was $2,991,000 specifically allocated. There was $13.9 million of unpaid principal on impaired loans at June 30, 2012 compared to $15.8 million at year-end 2011. At June 30, 2012, there was $6.2 million of unpaid principal on impaired loans requiring no reserves, a decrease of $1.2 million since year-end 2011.  In the first half of 2012, one loan for $119,000 was removed from troubled debt status. There was no specific allocation for the loan at year-end 2011.

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 2011 to June 30, 2012, the recorded investment in past due and non-accrual loans decreased by $2.0 million. This was evidenced by a $1.3 million decrease in the recorded investment in past due loans still accruing interest and a $725,000 decrease in the recorded investment in non-accrual loans in the first six months of 2012.

The recorded investment of accruing loans past due 30-59 days was $24,000 at June 30, 2012; a decrease of $851,000 since December 31, 2011. The decrease is mostly the result of activities on two loans. One loan for $545,000 was charged off and one for $196,000 was brought current as part of a workout deal. At June 30, there were 4 loans past due 30-59 days.

The recorded investment of accruing loans past due 60-89 days decreased $369,000 since year-end 2011 and was $25,000 at June 30, 2012. The entire balance past due at year-end 2011 was related to one customer. In the first part of 2012, the Bank did a workout with the customer which involved a non-real estate collateral liquidation

 
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
and a principal paydown. The loans are performing now.  At June 30, there were only two loans comprising the entire past due balance.

There were no loans with a recorded investment past due 90 days and greater at June 30, 2012 still accruing interest. There was $27,000 past due 90 days and greater at year-end 2011.

The Bank’s delinquency is very low compared to prior periods and continues to trend downward. The credit review process will continue to be stringent; however it is possible that past dues could fluctuate in future periods.

In addition to a decline in delinquency in the first half of the year, the recorded investment of non-accrual loans decreased $725,000. At June 30, 2012, the recorded investment of non-accrual loans was $5.9 million. From a past due standpoint, 29% of the recorded investment in non-accrual loans were past due greater than 90 days on June 30, 2012; a majority of the non-accrual loans are paying as agreed and will possibly be eligible to return to full accrual in the future.

Overall net charge-offs for the second quarter of 2012 were $113,000 and were $1.1 million for the first half of 2012. The corresponding ratio of net charge-offs to average loans for the second quarter of 2012 was 0.32% while the ratio of net charge-offs to average loans was 1.47% for the first half of 2012.

In the first quarter of 2012, a large commercial real estate credit was restructured in a modification that is commonly referred to as an A-B note structure. In these types of modifications, a detailed analysis of the borrower’s financial condition is performed and the total debt is separated into two notes. The first note (“note A”) is underwritten to be supported by current cash flows and collateral and the second note (“note B”) is made for the remaining unsecured debt. Note B is immediately charged-off after closing with collection occurring only after note A is completely repaid. Sixty-six percent of the charge-offs recorded in the first quarter of 2012 was the note B of a commercial real estate restructuring. Aside from that single transaction, other charge offs would have been less than 1% of total loans during the first six months of 2012.

The net charge-offs for the second quarter of 2011 were $818,000 and $1.1 million for the first half of 2011. The resulting ratio of net charge-offs to average loans for the second quarter of 2011 was 2.00% and 1.29% for the first half of the same year.

Although the six month ratios of net charge-offs to average loans for both years are not comparable to normal historical charge-off ratios, it is encouraging that there has been a decrease and similar to the local economy, there appears to be a trend of stabilization.

Another risk identified by the Company is interest rate risk. The Company attempts to mitigate interest rate risk in its loan portfolio in many ways. In addition to product diversification, two other methods used are to balance the rate sensitivity of the portfolio and avoid extension risk1.
____________
1 
Extension risk, as related to loans, exists when booking fixed rate loans with long final contractual maturities. When a customer is contractually allowed longer to return its borrowed principal and rates rise, the Bank is delayed from taking advantage of the opportunity to reinvest the returning principal at the higher market rate.
 
 
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The loan maturities and rate sensitivity of the loan portfolio at June 30, 2012 are set forth below:

   
Within
   
Three to
   
One to
   
After
       
   
Three Months
   
Twelve Months
   
Five Years
   
Five Years
   
Total
 
    Commercial
  $ 5,637,613     $ 15,772,201     $ 17,138,051     $ 4,004,166     $ 42,552,031  
    Commercial Real Estate:
                                       
      General
    4,593,666       10,315,801       35,558,589       2,002,566       52,470,622  
      Construction
    1,436,805       2,254,548       2,161,780       42,013       5,895,146  
    Consumer:
                                       
      Lines of credit
    703,261       2,514,790       3,794,320       5,212,759       12,225,130  
      Other
    167,785       176,488       1,055,474       737,852       2,137,599  
      Credit card
    59,022       183,075       281,127       0       523,224  
    Residential
    0       0       7,208       16,562,950       16,570,158  
    $ 12,598,152     $ 31,216,903     $ 59,996,549     $ 28,562,306     $ 132,373,910  
Loans at fixed rates
  $ 9,960,987     $ 22,007,828     $ 48,689,033     $ 22,319,636     $ 102,977,484  
Loans at variable rates
    2,637,165       9,209,075       11,307,516       6,242,670       29,396,426  
    $ 12,598,152     $ 31,216,903     $ 59,996,549     $ 28,562,306     $ 132,373,910  

At June 30, 2012, there were 78% of the loan balances carrying a fixed rate and 22% a floating rate. Since 2008, the Bank’s concentration of fixed rate loans has been increasing. Some of the shift is a factor of the types of loans that have paid off or have been added to the portfolio and some of the change is related to customer preference at the time of renewal. It is likely that future rate movements will be rising given the extended period of low rates that has existed over the past few years. As a result of the current mix of the loan portfolio, management will be challenged to improve loan income in a rising rate environment.

The maturity distribution of the loan portfolio has lengthened over the last several years but still remains at a level which is within the parameters determined to be acceptable by management. Contributing to the change in distribution is the increase in the mortgage loan portfolio over the past several years. Typically management strives to retain only 10-15% of residential mortgages originated because of the longer contractual terms generally associated with mortgage products. At June 30, 2012, approximately 22% of the entire loan portfolio had a contractual maturity longer than five years. To control extension risk mostly associated with the mortgage business line, management remains focused on originating loans saleable into the secondary market.

Premises and equipment were $9.4 million at June 30, 2012. This was a decrease of $957,000 from the balance of $10.4 million on December 31, 2011. In June, the Bank completed the sale of land it had purchased in the fourth quarter of 2006 for expansion of its branching system. The property was located on Apple Avenue in Muskegon County. The book value of the land sold was $788,000. There was a gain recorded of $208,000.

Foreclosed assets were $3.4 million at June 30, 2012 which was an increase of $80,000 since December 31, 2011. 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. In addition to several lot sales during the first six months of 2012, eight properties were added, ten properties sold and one property that

 
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
had no book value was relinquished to the county. At June 30, 2012 there were 28 real estate holdings and at December 31, 2011 there were 31 real estate holdings.

Deposit balances were $183.6 million at June 30, 2012 down from $191.5 million at December 31, 2011. Since year-end 2011, total deposits declined by $7.9 million or 4%. The decrease was the result of non-interest bearing deposits increasing $2.3 million being offset by total interest bearing deposits decreasing by $10.2 million.

In addition to non-interest bearing demand deposits increasing since year-end 2011, interest bearing demand deposits have also increased. The $2.3 million increase in non-interest bearing demand accounts was essentially the result of several existing business customers increasing their balances which offset the seasonal decrease in the balances of one of the Bank’s key public fund customers. Interest bearing checking balances increased $2.0 million since year-end 2011. Over 70% of the change since year-end 2011 is related to the Bank’s largest two public fund customers having more on deposit between the two period ends.

Since year-end 2011, money market balances declined by $487,000 and savings balances rose by $1.1 million. Primarily all of the change in outstanding balance is from existing customers.  Two customers are responsible for over 50% of the growth in savings accounts since year-end 2011.

Time deposits declined by a net figure of $12.7 million in the first six months of 2012. With a significant amount of unplanned loan repayments, the Bank has not focused on renewing time deposits in an attempt to reduce the liquidity in the Federal Reserve Bank. On April 30, the final brokered time deposit totaling $3.5 million matured. The Bank’s Consent Order with the FDIC prohibits the use of brokered deposits. The Bank has not issued any brokered deposits since January of 2010.

Repurchase agreement balances were $7.8 million at December 31, 2011 and $11.0 million at June 30, 2012; an increase of $3.2 million. A repurchase agreement is treated like a short-term borrowing of the Bank. To secure the short-term borrowing (repurchase agreement), balances held by customers are collateralized by high quality government securities held in a sub-account within the Bank’s security portfolio. This banking product has gotten more utilization since the FDIC program changed on December 31, 2010. Customers with investable dollars exceeding the FDIC limits are utilizing this account type because they are seeking higher interest rates while mitigating their risk. The increase in the balance between the two period ends was primarily from three existing repurchase customers keeping more money in their accounts at June 30, 2012 compared to year-end 2011.

Shareholders’ equity was negative on June 30, 2012. The balance was $(1.2 million) on that day. On December 31, 2011 the balance was $(1.4 million). There was an improvement of $230,000 which was made up of income recorded in the first six months of 2012 offset slightly by decreases in accumulated other comprehensive income (security market value adjustments).

The Bank’s capital ratios have risen since year-end 2011. At June 30, 2012, the Bank’s total risk-based capital ratio was 7.40% and its tier one to average assets ratio was 4.20%.  The Bank’s total risk-based capital ratio at December 31, 2011 was 6.40%. Its tier one to average assets ratio was 3.79% at year-end 2011. The total risk-based capital ratio improved as a result of recorded earnings and because of the favorable change in the mix of the Bank’s net risk -weighted assets. In spite of the improvement, on both period ends the Bank was considered under capitalized according to prompt corrective action regulations administered by federal banking agencies.
 
 
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COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Under the Consent Order, the Bank is required to have and maintain its level of tier one capital, as a percentage of its total assets, at a minimum of 8.5%, and its level of qualifying total capital, as a percentage of risk-weighted assets, at a minimum of 11%.   The Consent Order capital requirements were effective beginning with the December 31, 2010 capital reporting period.  The Bank was not in compliance with required capital ratios at any of the December 2010, 2011 or June 2012 capital reporting periods. In order to attain the level of capital required by the Consent Order, the Bank would have needed additional capital of $9,002,000 on June 30, 2012 based on its asset mix and size. This is a decrease of $1,318,000 compared to the $10,320,000 that would have been needed on December 31, 2011.

The Directive, issued by the FDIC to the Bank on August 17, 2011, stipulated that the Bank be restored to an “adequately capitalized” capital category by October 17, 2011. To reach a level of adequately capitalized, according to FDIC prompt corrective action guidance, the Bank would have needed a capital contribution of $866,000 based on its asset mix on June 30, 2012. Although the board made efforts to secure funding and comply with the Directive, they were not successful. As such, the Bank was not in compliance with the Directive by the required date and remains out of compliance. The board informed the FDIC in a letter dated October 14, 2011 that it was unable to comply with the Directive. There has been no further communications with the FDIC regarding the Directive. The board’s effort to garner capital for the Bank is continuing.

RESULTS OF OPERATIONS

Net income recorded for the first six months of 2012 was $258,000. There were losses of $1.3 million recorded for the first six months of 2011; an improvement of $1.5 million between similar periods of 2012 and 2011. The corresponding basic and diluted earnings per share for the first six months of 2012 was $0.18. The basic and diluted loss per share for the first half of 2011 was $(0.86).

The Company recorded net income of $322,000 for the second quarter of 2012. The corresponding basic and diluted earnings per share was $0.22 for the second quarter of 2012. Conversely, there was a loss of $522,000 recorded in 2011’s second quarter. The corresponding basic and diluted loss per share was $(0.36).

The income recorded in the first six months of 2012 stems primarily from reduced expenses related to administering troubled assets and a gain on the disposal of a capital asset. The loan loss provision, foreclosed asset impairments and other collection expenses totaled $576,000 for the first six months of 2012. For the similar period in 2011 the same expenses totaled $1.7 million. For the second quarter of 2012, loan loss provision, foreclosed asset impairments and other collection expenses totaled $242,000; a decrease of $543,000 from the second quarter of 2011. Expenses related to administering troubled assets have declined markedly over the last several quarters. With the stabilization in the local economy and minimal delinquency, it is reasonable to assume that troubled asset expenses have stabilized and may possibly continue to decline.
 
 
-46-

 
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

For the first six months of 2012, the annualized return on the Company’s average total assets was 0.24% compared to (1.06)% for the first six months of 2011. For the second quarter of 2012, the annualized return on the Company’s average total assets was 0.62%. For the second quarter of 2011, the ratio was (0.90)%. The Company’s annualized return on average equity was (37.52)% for the first six months of 2012 and (564.94)% for the first six months of 2011. For the second quarter of 2012, the annualized return on average equity was (98.94)% compared to (1898.18)% for the second quarter of 2011. The ratio of average equity to average assets was (0.65)% for the first six months of 2012 and 0.19% for the first six months of 2011. The ratio was (0.62)% for the second quarter of 2012 and 0.05% for the same period in 2011. Although the Company had recorded earnings in the second quarter and first six months of 2012, the shareholder’s equity of the Company was still a negative number making the equity ratios referenced above negative and appear contradictory to the operating results.
 
Another component of the Company’s revenue is its net interest income. Although the Company’s net interest income was lower for the first six months of 2012 compared to the similar period in 2011, the corresponding net interest margin was better mostly as a result of improvements made to the Company’s cost of average funds. 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.

 
-47-

 
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
   
Six Months ended June 30,
 
   
2012
   
2011
 
   
Average
         
Average
   
Average
         
Average
 
   
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
 
Assets
                                   
    Federal funds sold and interest-
                                   
      bearing deposits with banks
  $ 19,508,022     $ 23,615       0.24 %   $ 21,990,723     $ 26,430       0.24 %
    Securities
    36,016,572       373,247       2.07       35,975,068       450,881       2.51  
    Loans (including held for sale
                                               
      and non accrual)
    143,639,559       4,253,369       5.92       164,650,630       5,100,053       6.19  
      199,164,153       4,650,231       4.67       222,616,421       5,577,364       5.01  
    Other assets
    12,659,566                       13,610,779                  
    $ 211,823,719                     $ 236,227,200                  
Liabilities and Shareholders’ Equity
                                               
    Interest-bearing deposits
  $ 155,824,831     $ 760,668       0.98 %   $ 178,615,080     $ 1,576,417       1.77 %
    Repurchase agreements and
                                               
      FRB borrowings
    10,199,796       39,019       0.77       8,531,164       31,617       0.74  
    Subordinated debentures and
                                               
      notes payable
    9,500,000       214,844       4.52       9,500,000       207,051       4.36  
      175,524,627       1,014,531       1.16       196,646,244       1,815,085       1.85  
    Non-interest-bearing deposits
    36,395,962                       38,298,664                  
    Other liabilities
    1,276,058                       837,562                  
    Shareholders’ Equity
    (1,372,928 )                     444,730                  
    $ 211,823,719                     $ 236,227,200                  
Net interest income (tax equivalent
                                               
    basis)
            3,635,700                       3,762,279          
Net interest spread on earning assets
                                               
    (tax equivalent basis)
                    3.51 %                     3.16 %
Net interest margin on earning
                                               
    assets (tax equivalent basis)
                    3.65 %                     3.38 %
Average interest-earning assets to
                                               
    average interest-bearing liabilities
                    113.47 %                     113.21 %
Tax equivalent adjustment
            23,552                       26,159          
Net interest income
          $ 3,612,148                     $ 3,736,120          

The tax equivalent net interest spread on average earning assets increased 35 basis points to 3.51% in the past twelve months. The tax equivalent net interest margin increased by 27 basis points from 3.38% for the first six months of 2011 to 3.65% for the first six months of 2012. The tax equivalent net interest income for the first six months of 2012 was $3.6 million compared to a figure of $3.7 million for the same six months in 2011. Although there were $23.5 million fewer average earning assets in the first six months of 2012 compared to the similar period in 2011, the Company’s net interest income only decreased by $124,000 and the net interest margin improved. Improvement stemmed primarily from a change in the mix of funding resources and a decrease in the yield paid on interest bearing liabilities.
 
 
-48-

 
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The average rate earned on interest earning assets was 4.67% for the six month period ending June 30, 2012 compared to 5.01% for the same period in 2011. The main contributing factor was a reduction in the loan portfolio, the Company’s largest earning asset category. As the economy improves, businesses become healthier which strengthens their financial condition and allows them more banking options. As economic activity returns, many businesses are using excess liquidity to repay loans while others are pursuing lower rate financing at other financial institutions. The Company’s average loan portfolio is $21.0 million smaller than it was for the first six month period of 2011. Management will match competitor pricing to retain a customer when the rates adequately reflect borrower risk. Since the Bank’s internal prime lending rate is 175 basis points above the Wall Street Journal Prime Lending Rate, there is a lot of competitive pressure to revisit pricing on those customers that have recovered and are experiencing an improved financial condition.

Also contributing to the decreased yield on average earning assets is the marked decrease in the yield earned on the investment portfolio. Throughout last year, as securities matured, the replacement securities purchased yielded lower rates as a result of differences in the rate environment.

Fortunately, decreases to the overall yield on interest earning assets were more than offset by rate reductions on the funding side. Management spends a significant amount of time managing the continued improvement in the cost of funds, especially in light of the restrictions placed by the Consent Order. Interest expense incurred on rate-bearing liabilities improved by 69 basis points when comparing the first six months of 2012 to that of the similar period in 2011; a majority of the improvement was a 109 basis point reduction in the average rate paid on the time deposit portfolio over the last twelve months. With loan repayments in the first half of 2012, the Bank has been able to let maturing time deposits go without replacing them. When funding has been needed over the last twelve months, the Bank has been successful at securing lower rates.

The Bank’s customer repurchase agreement balance grew in the first half of 2012. The average outstanding in the first six months of 2012 was $1.7 million more than what it was in the same six month period of 2011. Additionally, the rate paid is 3 basis points higher. Rates have remained substantially the same however the product has tiered pricing which means that the mix of customer balances was different when comparing the two six month periods of 2011 and 2012 resulting in a higher overall yield.

Finally, the Company’s average rate paid on notes payable and subordinated debentures increased by 16 basis points between the first half of 2012 and the first half of 2011. The Company’s subordinated debt carried an average rate of 2.57% in the first half of 2012 which is roughly 21 basis points higher than an average rate of 2.36% paid for the same period in 2011.

 
-49-

 
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The quarter-to-quarter comparison of consolidated average interest earning assets and interest bearing liabilities and average yield on assets and average cost of liabilities for the second quarter ended June 30, 2012 and 2011 is in the table below.

   
Three Months ended June 30,
 
   
2012
   
2011
 
   
Average
         
Average
   
Average
         
Average
 
   
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
 
Assets
                                   
    Federal funds sold and interest-
                                   
      bearing deposits with banks
  $ 19,830,612     $ 11,880       0.24 %   $ 21,068,803     $ 12,736       0.24 %
    Securities
    37,003,288       186,277       2.01       35,407,386       219,236       2.48  
    Loans (including held for sale
                                               
      and non accrual)
    139,403,944       2,100,364       6.03       163,317,006       2,534,972       6.21  
      196,237,844       2,298,521       4.69       219,793,195       2,766,944       5.04  
    Other assets
    12,955,526                       13,100,894                  
    $ 209,193,370                     $ 232,894,089                  
Liabilities and Shareholders’ Equity
                                               
    Interest-bearing deposits
  $ 152,849,770     $ 356,395       0.93 %   $ 176,242,411     $ 764,822       1.74 %
    Repurchase agreements and
                                               
      FRB borrowings
    11,254,451       21,629       0.77       10,012,413       20,115       0.80  
    Subordinated debentures and
                                               
      notes payable
    9,500,000       106,865       4.50       9,500,000       104,161       4.39  
      173,604,221       484,889       1.12       195,754,824       889,098       1.82  
    Non-interest-bearing deposits
    35,533,166                       35,955,251                  
    Other liabilities
    1,356,291                       1,073,747                  
    Shareholders’ Equity
    (1,300,308 )                     110,267                  
    $ 209,193,370                     $ 232,894,089                  
Net interest income (tax equivalent
                                               
    basis)
            1,813,632                       1,877,846          
Net interest spread on earning assets
                                               
    (tax equivalent basis)
                    3.57 %                     3.22 %
Net interest margin on earning
                                               
    assets (tax equivalent basis)
                    3.70 %                     3.42 %
Average interest-earning assets to
                                               
    average interest-bearing liabilities
                    113.04 %                     112.28 %
Tax equivalent adjustment
            11,776                       12,428          
Net interest income
          $ 1,801,856                     $ 1,865,418          

Similar to the comparison of the year to date net interest income results above; there was an overall decrease in tax equivalent net interest income between the second quarter results of 2012 and that of 2011. Tax equivalent net interest income declined by $64,000. Decreases to the blended rate earned on the average earning assets fell by 35 basis points but was more than offset by the 70 basis point improvement in the Company’s average cost of funds. The tax equivalent net interest spread rose by 35 basis points between the second quarter of 2011 and the similar period in 2012. The net interest margin on earning assets was 3.70% for the second quarter of 2012; an improvement of 28 basis points compared to the second quarter of 2011. Given the unexpected loan repayments and the higher than expected liquidity at the FRB, it may be difficult to continue improving the Company’s net interest margin in the second half of 2012. Any anticipated improvements to the net interest margin are likely to come from utilizing excess liquidity to fund time deposits maturities and to continue to reprice new time deposits to current rates.
 
 
-50-

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

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

Details of the repricing gap at June 30, 2012 were:

   
Interest Rate Sensitivity Period
 
   
Within Three
   
Three to Twelve
   
One to Five
   
After Five
       
   
Months
   
Months
   
Years
   
Years
   
Total
 
Earning assets
                             
    Interest-bearing deposits
                             
      in other financial institutions
  $ 15,242,760     $ 0     $ 0     $ 0     $ 15,242,760  
    Securities (including FHLB stock)
    5,656,500       7,845,787       20,855,709       2,974,518       37,332,514  
    Loans held for sale
    47,099       151,216       819,709       5,052,449       6,070,473  
    Loans
    45,282,832       20,278,710       50,598,004       16,214,364       132,373,910  
      66,229,191       28,275,713       72,273,422       24,241,331       191,019,657  
Interest-bearing liabilities
                                       
    Savings and checking
    48,914,771       0       0       0       48,914,771  
    Time deposits <$100,000
    9,786,661       32,679,220       46,557,650       0       89,023,531  
    Time deposits >$100,000
    2,503,217       4,330,114       3,280,864       0       10,114,195  
    Repurchase agreements and
                                       
      Federal funds purchased
    10,993,728       0       0       0       10,993,728  
    Notes payable and other
                                       
      borrowings
    9,500,000       0       0       0       9,500,000  
      81,698,377       37,009,334       49,838,514       0       168,546,225  
Net asset (liability) repricing gap
  $ (15,469,186 )   $ (8,733,621 )   $ 22,434,908     $ 24,241,331     $ 22,473,432  
Cumulative net asset (liability)
                                       
      repricing gap
  $ (15,469,186 )   $ (24,202,807 )   $ (1,767,899 )   $ 22,473,432          
 
 
-51-

 
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Currently, the Company has a negative twelve month repricing gap which indicates that the Company is liability sensitive in the next twelve month period. This position implies that more rate bearing products have an opportunity to reprice during this period. If the rate environment remains flat like the FRB has forecasted, a negative repricing gap should be helpful for further reduction to the Company’s overall interest expense which could translate into higher net interest income and an increased net interest margin assuming there is not continued shrinkage or significant decline in the interest earned on the Company’s loan portfolio. If the Company’s gap position remains negative when interest rates begin to rise, there will likely be a negative effect on net interest income. The interest rate sensitivity table simply illustrates what the Company is contractually able to change in certain time frames.

The provision for loan losses for the first six months of 2012 was $75,000 compared to $1.2 million for first half of 2011. The second quarter provision for loan losses was $498,000 for 2011 but none was recorded for the second quarter of 2012. The provision expenses are associated with changes in historical loss calculations, economic condition as well as delinquency, loan charge offs and downgrades. A methodical assessment of these factors generates the reserves required for the risk in the Bank’s loan portfolio. Over the past few years, general allocations to the loan loss reserve were increasing as a result of the weakening economy and the emphasis being placed on recent loss history. Currently, general allocations are declining as a result of stabilization in the local economy and improved trends in delinquency and charge off activity and decreasing loan balances for which reserves are made.

Specific allocations to the loan loss reserve have also decreased in the first six months of the year. At June 30, 2012, the allowance for loan loss included specific allocations of $2.5 million, approximately $475,000 less than at December 31, 2011. At June 30, 2011, specific allocations were similar to the same period end in 2012 at a level of $2.4 million.

The allowance for loan losses is an estimate. Management believes that the allowance level is adequate and justified based on the factors discussed earlier (see Financial Condition). Management will continue to review the allowance with the intent of maintaining it at an appropriate level. The provision may be increased or decreased in the future as management continues to monitor the loan portfolio, actual loan loss experience and the environmental factors related to lending and collateral.

Non-interest income recorded in the first six months of 2012 was $876,000 compared to $880,000 recorded for the similar period in 2011. Although the totals are similar, decreases in recurring income sources such as overdraft fee income and gains on the sale of loans, were offset by a gain of $208,000 on the disposal of land that was originally acquired to build a fifth branch of the Bank.

Non-interest income for the second quarter of 2012 was $575,000 compared to $360,000 of non-interest income in the second quarter of 2011. The $208,000 gain on the land sale mentioned above was a majority of the difference in the results between the second quarter of 2012 and that of 2011. From a recurring income standpoint, the increases in the gain on sale of loans offset decreases in overdraft fee income.

Non-interest expenses for the first six months of 2012 were $4.2 million. Non-interest expenses for the first six months of 2011 were $4.7 million. Decreases to salary and benefit expenses and impairment on foreclosed assets comprised 72% of the decrease in the first half of the year. Non-interest expenses were $2.1 million for the second quarter of 2012 compared to $2.3 million for the similar period in 2011. The decline of $195,000 was attributable to reductions in the same two non-interest expense categories.
 
 
-52-

 
COMMUNITY SHORES BANK CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Salary and benefit expenses, the largest category of non-interest expenses, were $1.9 million for the first half of 2012. For the similar period in 2011, the total was $2.1 million. There were on average 6 fewer full time equivalent (“FTE”) employees when comparing the two time periods. A majority of the decrease was related to retirements. In the last twelve months, one part time and three full time employees retired. Other vacancies were related to the timing of turnover and may not be a permanent decrease in FTE’s. Salary and benefit expenses for the second quarter of 2012 were $919,000, $108,000 less than the total for the same period in 2011.

There were foreclosed asset impairment charges of $185,000 in the first half of 2012. These results compare to $393,000 in the first half of 2011. In the second quarter of 2012, foreclosed asset impairment charges were $94,000 or $131,000 less than the like period in 2011. 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 value 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. Although impairment charges continue to occur, the total decreased in the first two quarters of 2012 compared to the first two quarters of 2011. The decrease is caused by two things, the Bank’s portfolio of foreclosed real property is declining and the values of the properties within the portfolio appear to be stabilizing for the time being. At June 30, 2012, there were 28 foreclosed assets totaling $3.4 million.

There was no income tax expense in either the first six months of 2012 or that of 2011.

ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable for smaller reporting companies.

ITEM 4.   CONTROLS AND PROCEDURES

An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of June 30, 2012. Based on the evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were, to the best of their knowledge, effective as of June 30, 2012. There have been no significant changes in the internal controls over financial reporting during the quarter ended June 30, 2012, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
 
 
-53-

 
COMMUNITY SHORES BANK CORPORATION
 
PART II – OTHER INFORMATION

ITEM 1.   LEGAL PROCEEDINGS

In the opinion of management, the Company and its subsidiaries are not a party to any current legal proceedings that are expected to have a material adverse effect on their financial condition, either individually or in the aggregate.

ITEM 1A.   RISK FACTORS

Not applicable for smaller reporting companies.

ITEM 2.       UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The Company made no unregistered sale of equity securities, and did not purchase any of its equity securities, during the quarter ended June 30, 2012.

Holders of Company common stock are entitled to receive cash dividends to the extent that they are declared from time to time by the Company's Board of Directors.  To date, the Company's Board of Directors has never declared a cash dividend.  The Company may only pay cash dividends out of funds that are legally available for that purpose.  The Company is a holding company and substantially all of its assets are held by its subsidiaries.  The Company's ability to pay cash dividends to its shareholders depends primarily on the Bank's ability to pay cash dividends to the Company.  Cash dividend payments and extensions of credit to the Company from the Bank are subject to legal and regulatory limitations, generally based on capital levels and current and retained earnings, imposed by law and regulatory agencies with authority over the Bank.  The ability of the Bank to pay cash dividends is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements.  Under the Consent Order and Written Agreement, the Bank is precluded from paying dividends to the Company and the Company may not receive dividends from the Bank.

Under the terms of the subordinated debentures that the Company issued to the Trust, the Company is precluded from paying cash dividends on the Company's common stock if an event of default has occurred and is continuing under the subordinated debentures, or if the Company has exercised its right to defer payments of interest on the subordinated debentures, until the deferral ends.  In May of 2010, the Company gave notice that it was deferring the regularly scheduled quarterly interest payments on the subordinated debentures beginning with the quarterly interest payment that was scheduled to be paid on June 30, 2010.  So until the deferral ends, the terms of the subordinated debentures preclude the Company from paying any dividends on the common stock.  If the Company had any preferred stock outstanding, it would similarly be precluded from paying any dividend on the preferred stock.
 
 
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COMMUNITY SHORES BANK CORPORATION
 
ITEM 3.       DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4.       MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.       OTHER INFORMATION

None.

ITEM 6.       EXHIBITS

EXHIBIT NO.
EXHIBIT DESCRIPTION
   
3.1
Articles of Incorporation are incorporated by reference to exhibit 3.1 of the Company’s June 30, 2004 Form 10-QSB (SEC file number 333-63769).
3.2
Bylaws of the Company are incorporated by reference to exhibit 3(ii) of the Company’s Form 8-K filed July 5, 2006 (SEC file number 000-51166).
31.1
Rule 13a-14(a) Certification of the principal executive officer.
31.2
Rule 13a-14(a) Certification of the principal financial officer.
32.1
Section 1350 Chief Executive Officer Certification.
32.2
Section 1350 Chief Financial Officer Certification.
   
   
 
 
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


 
COMMUNITY SHORES BANK CORPORATION
 
 
   
August 14, 2012
By:  /s/ Heather D. Brolick
Date
Heather D. Brolick
 
President and Chief Executive Officer
 
(principal executive officer)
   
   
   
August 14, 2012
By:  /s/ Tracey A. Welsh
Date
Tracey A. Welsh
 
Senior Vice President, Chief Financial Officer and Treasurer
 
(principal financial and accounting officer)



 
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EXHIBIT INDEX

EXHIBIT NO.
EXHIBIT DESCRIPTION
   
3.1
Articles of Incorporation are incorporated by reference to exhibit 3.1 of the Company’s June 30, 2004 Form 10-QSB (SEC file number 333-63769).
3.2
Bylaws of the Company are incorporated by reference to exhibit 3(ii) of the Company’s Form 8-K filed July 5, 2006 (SEC file number 000-51166).
31.1
Rule 13a-14(a) Certification of the principal executive officer.
31.2
Rule 13a-14(a) Certification of the principal financial officer.
32.1
Section 1350 Chief Executive Officer Certification.
32.2
Section 1350 Chief Financial Officer Certification.
 
 
 
 
 
 
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