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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarterly period ended September 30, 2004. Commission file number 000-24478. DEARBORN BANCORP, INC.  Michigan
    
    38-3073622(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 1360 Porter Street, Dearborn,
MI
    
    48124(Address of principal executive office)
    
    (Zip Code)
 (313) 565-5700
(Registrants telephone number, including area code) N/A
(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. Yes X      No Indicate the number of shares outstanding for each of the issuers classes of
common stock, as of October 31, 2004. Class
    
    Shares OutstandingCommon Stock
    
    
    4,545,210
 Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the 1934 Securities and Exchange Act). Yes       No X




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##### Table of Contents



DEARBORN BANCORP, INC.
INDEX PagePart I.
    
    
    
    Financial Information:Item 1.
    
    
    
    Financial StatementsThe following consolidated financial statements of Dearborn
Bancorp, Inc. and its subsidiary included in this report are:Independent Accountants Report
    
    
    3Consolidated Balance Sheets  September 30, 2004,December 31, 2003 and September 30, 2003
    
    
    4Consolidated Statements of Income  For the Three and NineMonths Ended September 30, 2004 and 2003
    
    
    5Consolidated Statements of Comprehensive Income  For theThree and Nine Months Ended September 30, 2004 and 2003
    
    
    6Consolidated Statements of Cash Flows  For theNine Months Ended September 30, 2004 and 2003
    
    
    7Notes to Consolidated Financial Statements
    

8 - 11Item 2.
    
    
    
    Managements Discussion and Analysis of FinancialCondition and Results of Operations, Liquidity and Capital
    

12 - 26Item 3.
    
    
    
    Quantitative and Qualitative Disclosures about Market Risk
    

27 - 29Item 4.
    
    
    
    Controls and Procedures
    
    
    30Part II.
    
    
    
    Other Information:Pursuant to SEC rules and regulations, the following item(s) are included with the Form 10-Q Report:Item 6. Exhibits and Reports on Form 8-K
    
    
    31Pursuant to SEC rules and regulations, the following items are omitted from this Form 10-Q as inapplicable or to which the answer is negative:Item 1. Legal ProceedingsItem 2. Changes in Securities and Use of ProceedsItem 3. Defaults upon Senior SecuritiesItem 4. Submission of Matters to a Vote of Security HoldersItem 5 Other InformationSIGNATURES
    
    
    
    
    
    
    32Certification of Chief Executive Officer Pursuant to Section 302Certification of Chief Financial Officer Pursuant to Section 302Certifications Pursuant to Section 906Certifications Pursuant to Section 906
 2




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REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Shareholders
Dearborn Bancorp, Inc.
Dearborn, Michigan We have reviewed the consolidated balance sheets of Dearborn Bancorp, Inc. as
of September 30, 2004 and 2003, the related consolidated statements of income
and comprehensive income for the three and nine month periods then ended, and
the related consolidated statements of cash flows for the nine month periods
then ended. These financial statements are the responsibility of the
Corporations management. We conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in
accordance with the standards of the Public Company Accounting Oversight Board,
the objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with accounting principles generally accepted in the United States
of America. /s/ Crowe Chizek and Company LLC Grand Rapids, Michigan
October 25, 2004 3




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DEARBORN BANCORP, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (unaudited) (Dollars, in thousands)9/30/04
    
    12/31/03
    
    9/30/03ASSETSCash and cash equivalentsCash and due from banks
    
    $
    6,343
    
    
    $
    5,172
    
    
    $
    6,182Federal funds sold
    
    
    11,636
    
    
    
    7,651
    
    
    
    7,384Interest bearing deposits with banks
    
    
    29,600
    
    
    
    8,325
    
    
    
    128Total cash and cash equivalents
    
    
    47,579
    
    
    
    21,148
    
    
    
    13,694Mortgage loans held for sale
    
    
    1,533
    
    
    
    1,505
    
    
    
    2,727Investment securities, available for sale
    
    
    39,516
    
    
    
    16,948
    
    
    
    11,933Federal Home Loan Bank stock
    
    
    1,111
    
    
    
    1,073
    
    
    
    1,060LoansLoans
    
    
    474,111
    
    
    
    400,958
    
    
    
    374,963Allowance for loan loss
    
    
    (5,188
    )
    
    
    (4,314
    )
    
    
    (4,016
    )Net loans
    
    
    468,923
    
    
    
    396,644
    
    
    
    370,947Premises and equipment, net
    
    
    10,987
    
    
    
    5,554
    
    
    
    5,586Real estate owned
    
    
    357
    
    
    
    
    
    
    
    Accrued interest receivable
    
    
    1,648
    
    
    
    1,461
    
    
    
    1,377Other assets
    
    
    2,439
    
    
    
    1,742
    
    
    
    1,963Total assets
    
    $
    574,093
    
    
    $
    446,075
    
    
    $
    409,287LIABILITIESDepositsNon-interest bearing deposits
    
    $
    45,136
    
    
    $
    39,081
    
    
    $
    36,032Interest bearing deposits
    
    
    423,878
    
    
    
    340,538
    
    
    
    307,793Total deposits
    
    
    469,014
    
    
    
    379,619
    
    
    
    343,825Other liabilitiesFederal Home Loan Bank advances
    
    
    20,614
    
    
    
    20,638
    
    
    
    20,638Other liabilities
    
    
    1,140
    
    
    
    463
    
    
    
    726Accrued interest payable
    
    
    928
    
    
    
    754
    
    
    
    651Subordinated debentures
    
    
    10,000
    
    
    
    10,000
    
    
    
    10,000Total liabilities
    
    
    501,696
    
    
    
    411,474
    
    
    
    375,840STOCKHOLDERS EQUITYCommon stock  5,000,000 shares authorized,
4,538,958 shares at 09/30/04, 3,089,567 shares at
12/31/02; and 3,083,460 shares at 09/30/03
    
    
    71,370
    
    
    
    34,451
    
    
    
    32,379Retained earnings
    
    
    1,590
    
    
    
    128
    
    
    
    1,037Accumulated other comprehensive loss
    
    
    (563
    )
    
    
    22
    
    
    
    31Total stockholders equity
    
    
    72,397
    
    
    
    34,601
    
    
    
    33,447Total liabilities and stockholders equity
    
    $
    574,093
    
    
    $
    446,075
    
    
    $
    409,287
 The accompanying notes are an integral part of these consolidated statements. 4




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DEARBORN BANCORP, INC. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF INCOME (unaudited) (In thousands, except share and per share data)
    
    Three Months Ended
    
    Nine Months Ended09/30/04
    
    09/30/03
    
    09/30/04
    
    09/30/03Interest incomeInterest on loans, including fees
    
    $
    7,142
    
    
    $
    6,035
    
    
    $
    20,296
    
    
    $
    16,487Interest on securities, available for sale
    
    
    155
    
    
    
    62
    
    
    
    293
    
    
    
    450Interest on federal funds
    
    
    49
    
    
    
    18
    
    
    
    87
    
    
    
    97Interest on deposits with banks
    
    
    80
    
    
    
    1
    
    
    
    97
    
    
    
    131Total interest income
    
    
    7,426
    
    
    
    6,116
    
    
    
    20,773
    
    
    
    17,165Interest expenseInterest on deposits
    
    
    2,080
    
    
    
    1,613
    
    
    
    5,443
    
    
    
    5,456Interest on other borrowings
    
    
    234
    
    
    
    235
    
    
    
    696
    
    
    
    695Interest on subordinated debentures
    
    
    109
    
    
    
    123
    
    
    
    332
    
    
    
    368Total interest expense
    
    
    2,423
    
    
    
    1,971
    
    
    
    6,471
    
    
    
    6,519Net interest income
    
    
    5,003
    
    
    
    4,145
    
    
    
    14,302
    
    
    
    10,646Provision for loan losses
    
    
    369
    
    
    
    671
    
    
    
    874
    
    
    
    1,410Net interest income after provision for loan
    
    
    4,634
    
    
    
    3,474
    
    
    
    13,428
    
    
    
    9,236Non-interest incomeService charges on deposit accounts
    
    
    141
    
    
    
    117
    
    
    
    409
    
    
    
    330Fees for other services to customers
    
    
    (10
    )
    
    
    7
    
    
    
    24
    
    
    
    22Gain on the sale of loans
    
    
    119
    
    
    
    605
    
    
    
    493
    
    
    
    1,906Gain on the sale of investment securities
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    89Loss on the sale of real estate
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    
    Other income
    
    
    (4
    )
    
    
    33
    
    
    
    48
    
    
    
    82Total non-interest income
    
    
    246
    
    
    
    772
    
    
    
    971
    
    
    
    2,429Non-interest expensesSalaries and employee benefits
    
    
    1,868
    
    
    
    1,534
    
    
    
    5,537
    
    
    
    4,579Commissions on the origination of loans
    
    
    52
    
    
    
    253
    
    
    
    202
    
    
    
    814Occupancy and equipment expense
    
    
    322
    
    
    
    369
    
    
    
    1,046
    
    
    
    1,040Advertising and marketing
    
    
    66
    
    
    
    64
    
    
    
    223
    
    
    
    208Stationery and supplies
    
    
    81
    
    
    
    82
    
    
    
    225
    
    
    
    267Professional services
    
    
    67
    
    
    
    68
    
    
    
    281
    
    
    
    280Data processing
    
    
    82
    
    
    
    86
    
    
    
    229
    
    
    
    241Other operating expenses
    
    
    217
    
    
    
    265
    
    
    
    651
    
    
    
    684Total non-interest expenses
    
    
    2,755
    
    
    
    2,721
    
    
    
    8,394
    
    
    
    8,113Income before income tax provision
    
    
    2,125
    
    
    
    1,525
    
    
    
    6,005
    
    
    
    3,552Income tax provision
    
    
    723
    
    
    
    515
    
    
    
    2,039
    
    
    
    1,203Net income
    
    $
    1,402
    
    
    $
    1,010
    
    
    $
    3,966
    
    
    $
    2,349Per share data:Net income  basic
    
    $
    0.34
    
    
    $
    0.33
    
    
    $
    1.15
    
    
    $
    0.77Net income  diluted
    
    $
    0.31
    
    
    $
    0.30
    
    
    $
    1.04
    
    
    $
    0.70Weighted average number of shares outstanding  basic
    
    
    4,158,113
    
    
    
    3,074,513
    
    
    
    3,463,636
    
    
    
    3,054,181Weighted average number of shares outstanding  diluted
    
    
    4,502,741
    
    
    
    3,371,891
    
    
    
    3,801,828
    
    
    
    3,349,608
 The accompanying notes are an integral part of these consolidated statements. 5




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DEARBORN BANCORP, INC. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited) (In thousands)
    
    Three Months Ended
    
    Nine Months Ended09/30/04
    
    09/30/03
    
    09/30/04
    
    09/30/03Net income
    
    $
    1,402
    
    
    $
    1,010
    
    
    $
    3,966
    
    
    $
    2,349Other comprehensive income (loss), net of taxUnrealized gains (losses) on securitiesUnrealized holding gains (losses) arising during period
    
    
    (552
    )
    
    
    (6
    )
    
    
    (886
    )
    
    
    14Less: reclassification adjustment for gains included
in net income
    
    
    
    
    
    
    (10
    )
    
    
    
    
    
    
    (89
    )Tax effects
    
    
    187
    
    
    
    6
    
    
    
    301
    
    
    
    27Other comprehensive loss
    
    
    (365
    )
    
    
    (10
    )
    
    
    (585
    )
    
    
    (48
    )Comprehensive income
    
    $
    1,037
    
    
    $
    1,000
    
    
    $
    3,381
    
    
    $
    2,301
 The accompanying notes are an integral part of these consolidated statements. 6




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DEARBORN BANCORP, INC. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (In thousands)
    
    Nine Months Ended9/30/04
    
    9/30/03Cash flows from operating activitiesInterest and fees received
    
    $
    20,447
    
    
    $
    17,048Interest paid
    
    
    (5,965
    )
    
    
    (6,477
    )Taxes paid
    
    
    (1,500
    )
    
    
    (1,825
    )Proceeds from sale of mortgages held for sale
    
    
    32,667
    
    
    
    129,111Origination of mortgages held for sale
    
    
    (32,343
    )
    
    
    (120,080
    )Cash paid to suppliers and employees
    
    
    (8,243
    )
    
    
    (7,446
    )Net cash provided by operating activities
    
    
    5,063
    
    
    
    10,331Cash flows from investing activitiesProceeds from maturities of securities available for sale
    
    
    11,000
    
    
    
    19,575Proceeds from call of securities available for sale
    
    
    325
    
    
    
    Proceeds from sales of securities available for sale
    
    
    5,884
    
    
    
    6,089Proceeds from repayments of securities available for sale
    
    
    326
    
    
    
    882Purchases of securities available for sale
    
    
    (40,949
    )
    
    
    (16,412
    )Purchases of Federal Home Loan Bank stock
    
    
    (38
    )
    
    
    (27
    )Increase in loans, net of payments received
    
    
    (73,153
    )
    
    
    (107,709
    )Purchases of property and equipment
    
    
    (5,812
    )
    
    
    (657
    )Net cash used in investing activities
    
    
    (102,417
    )
    
    
    (98,259
    )Cash flows from financing activitiesNet increase in non-interest bearing deposits
    
    
    6,055
    
    
    
    3,575Net increase in interest bearing deposits
    
    
    83,340
    
    
    
    78,164Repayments of Federal Home Loan Bank advances
    
    
    (24
    )
    
    
    (22
    )Issuance of common stock
    
    
    34,038
    
    
    
    Stock option exercise
    
    
    376
    
    
    
    455Net cash provided by financing activities
    
    
    123,785
    
    
    
    82,172Increase (decrease) in cash and cash equivalents
    
    
    26,431
    
    
    
    (5,756
    )Cash and cash equivalents at the beginning of the period
    
    
    21,148
    
    
    
    19,450Cash and cash equivalents at the end of the period
    
    $
    47,579
    
    
    $
    13,694Reconciliation of net income to net cash used in operating activitiesNet income
    
    $
    3,966
    
    
    $
    2,349Adjustments to reconcile net income to net cash used in operating activitiesProvision for loan losses
    
    
    874
    
    
    
    1,410Depreciation and amortization expense
    
    
    379
    
    
    
    347Accretion of discount on investment securities
    
    
    (53
    )
    
    
    (6
    )Amortization of premium on investment securities
    
    
    12
    
    
    
    169Gain on the sale of securities, available for sale
    
    
    
    
    
    
    (89
    )(Increase) decrease in mortgages held for sale
    
    
    (28
    )
    
    
    7,125Increase in interest receivable
    
    
    (187
    )
    
    
    (117
    )Increase in interest payable
    
    
    174
    
    
    
    42Increase in other assets
    
    
    (751
    )
    
    
    (571
    )Increase (decrease) in other liabilities
    
    
    677
    
    
    
    (328
    )Net cash provided by operating activities
    
    $
    5,063
    
    
    $
    10,331The accompanying notes are an integral part of these consolidated statements.
 7




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  A.
    
    Accounting and Reporting Policies The consolidated financial statements of Dearborn Bancorp, Inc. (the
Corporation) include the consolidation of its only subsidiary,
Community Bank of Dearborn (the Bank). The accounting and reporting
policies of the Corporation are in accordance with generally accepted
accounting principles and conform to practice within the banking
industry. The consolidated financial statements of the Corporation as of September
30, 2004 and 2003, and December 31, 2003 and for the three and nine
month periods ended September 30, 2004 and 2003 reflect all adjustments,
consisting of normal recurring items which are in the opinion of
management, necessary for a fair presentation of the results for the
interim period. The operating results for the quarter are not
necessarily indicative of results of operations for the entire year. The consolidated financial statements as of September 30, 2004 and 2003,
and for the three and nine month periods ended September 30, 2004 and
2003 included herein have been prepared by the Corporation, without an
audit, pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures
normally included in interim financial statements prepared in accordance
with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations. These financial
statements should be read in conjunction with the financial statements
and notes thereon included in the Corporations 2003 Annual Report to
Stockholders on Form 10-K. Certain of the Corporations accounting policies are important to the
portrayal of the Corporations financial condition, since they require
management to make difficult, complex or subjective judgments, some of
which may relate to matters that are inherently uncertain. Estimates
associated with these policies are susceptible to material changes as a
result of changes in facts and circumstances. Facts and circumstances
which could affect these material judgments include, but without
limitation, changes in interest rates, in the performance of the economy
or in the financial condition of borrowers. Management believes that
its critical accounting policies include determining the allowance for
loan losses and determining the fair value of securities and other
financial instruments. 8




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##### Table of Contents



A.
    
    Accounting and Reporting Policies (continued) Employee compensation expense under stock option plans is reported using
the intrinsic value method. No stock-based compensation cost is
reflected in net income, as all options granted had an exercise price
equal to or greater than the market price of the underlying common stock
at date of grant. The following table illustrates the effect on net
income and earnings per share if expense was measured using the fair
value recognition provisions of FASB Statement No. 123, Accounting for
Stock-based Compensation (in thousands, except share and per share
data). Three Months Ended
    
    Nine Months Ended09/30/04
    
    09/30/03
    
    09/30/04
    
    09/30/03Net incomeAs reported
    
    $
    1,402
    
    
    $
    1,010
    
    
    $
    3,966
    
    
    $
    2,349Less: stock-based compensation expense
determined under fair value based method
    
    
    
    
    
    $
    59
    
    
    
    9
    
    
    
    801Pro forma
    
    $
    1,402
    
    
    $
    951
    
    
    $
    3,957
    
    
    $
    1,548Basic income per shareAs reported
    
    $
    0.34
    
    
    $
    0.33
    
    
    $
    1.15
    
    
    $
    0.77Pro forma
    
    $
    0.34
    
    
    $
    0.31
    
    
    $
    1.14
    
    
    $
    0.51Diluted income per shareAs reported
    
    $
    0.31
    
    
    $
    0.30
    
    
    $
    1.04
    
    
    $
    0.70Pro forma
    
    $
    0.31
    
    
    $
    0.28
    
    
    $
    1.04
    
    
    $
    0.47
 Stock options vest after a six month period from date of grant. No
options were granted in 2004. The pro forma effects are computed using
option pricing models and the assumptions for the 2003 grants were a
risk-free interest rate of 3.55%, expected life of seven years, and
expected volatility of 25.55%. 9




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##### Table of Contents



B.
    
    Securities Available For Sale The amortized cost and estimated market value of securities available for
sale are as follows (in thousands): September 30, 2004Gross
    
    Gross
    
    EstimatedAmortized
    
    Unrealized
    
    Unrealized
    
    MarketCost
    
    Gains
    
    Losses
    
    ValueMortgage backed securities
    
    $
    870
    
    
    $
    25
    
    
    $
    
    
    
    $
    895Corporate debt securities
    
    
    17,854
    
    
    
    1
    
    
    
    
    
    
    
    17,855Government agency securities
    
    
    17,645
    
    
    
    1
    
    
    
    
    
    
    
    17,646FHLMC preferred stock
    
    
    4,000
    
    
    
    
    
    
    
    (880
    )
    
    
    3,120Totals
    
    $
    40,369
    
    
    $
    27
    
    
    
    ($880
    )
    
    $
    39,516
 December 31, 2003Gross
    
    Gross
    
    EstimatedAmortized
    
    Unrealized
    
    Unrealized
    
    MarketCost
    
    Gains
    
    Losses
    
    ValueUS Treasury securities
    
    $
    2,011
    
    
    $
    2
    
    
    $
    
    
    
    $
    2,013Mortgage backed securities
    
    
    1,194
    
    
    
    31
    
    
    
    
    
    
    
    1,225Corporate debt securities
    
    
    9,710
    
    
    
    
    
    
    
    
    
    
    
    9,710FHLMC preferred stock
    
    
    4,000
    
    
    
    
    
    
    
    
    
    
    
    4,000Totals
    
    $
    16,915
    
    
    $
    33
    
    
    $
    
    
    
    $
    16,948
 The amortized cost and estimated market value of securities available
for sale at September 30, 2004 by contractual maturity are shown below
(in thousands): EstimatedAmortized
    
    MarketCost
    
    ValueDue in over ten years
    
    $
    17,854
    
    
    $
    17,855Mortgage backed securities
    
    
    870
    
    
    
    895Government agency securities
    
    
    17,645
    
    
    
    17,646FHLMC preferred stock
    
    
    4,000
    
    
    
    3,120Totals
    
    $
    40,369
    
    
    $
    39,516
 The entire portfolio has a net unrealized loss of $853,000 at September
30, 2004. The Bank holds a floating rate issue of preferred stock of the
Federal Home Loan Mortgage Corporation that has an unrealized loss of
$880,000. This unrealized loss is primarily caused by the floating rate
characteristic of this security and its market value is expected to
improve as interest rates rise. The Corporation does not expect to
realize a loss as a
result of holding this security. The Corporation does not hold any
securities in the Held to Maturity category nor does the Corporation
hold or utilize derivatives. 10




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##### Table of Contents



C.
    
    Stock Option Plan Options to buy common stock are granted to officers and employees under a
Stock Option Plan which provides for issue of up to 747,790 shares.
Exercise price is the market price at date of grant. The maximum option
term is ten years, and options vest fully after six months from the date
of grant. If an option expires or terminates without having been
exercised, such option becomes available for future grant under the Plan. A summary of the option activity for the nine months ended September 30,
2004 is as follows: WeightedAvailable
    
    
    
    
    
    AverageFor
    
    Options
    
    ExerciseGrant
    
    Outstanding
    
    PriceOutstanding at January 1, 2004
    
    
    
    
    
    
    590,957
    
    
    $
    9.48Granted
    
    
    
    
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    (48,525
    )
    
    
    7.75Outstanding at September 30, 2004
    
    
    
    
    
    
    542,432
    
    
    $
    9.63
 For the options outstanding at September 30, 2004, the range of exercise
prices was $4.84 to $18.69 per share with a weighted-average remaining
contractual term of 6.3 years. At September 30, 2004, 542,432 options
were exercisable at weighted average exercise price of $9.63 per share.
Stock options for 4,631 shares of common stock were not considered in
computing diluted earnings per share for the nine months ended September
30, 2003 because they were antidilutive. There were no antidilutive
shares for the nine months ended September 30, 2004. 11




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##### Table of Contents



PART I    FINANCIAL INFORMATION 
 ITEM 2.    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
                    CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis are intended to address significant
factors affecting the financial condition and results of operations of the
Corporation. The discussion provides a more comprehensive review of the
financial position and operating results than can be obtained from a reading
of the financial statements and footnotes presented elsewhere in this report. Managements Discussion and Analysis of Financial Condition and Results of
Operations contains 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 Corporation and Bank.
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 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 Corporation
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 changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulation;
changes in tax laws; changes in prices, levies and assessments; the impact of
technological advances; governmental and regulatory policy changes; the
outcomes of contingencies; trends in customer behavior as well as their ability
to repay loans; and changes in the national and local economy. These are
representative of the Future Factors that could cause a difference between an
ultimate actual outcome and a preceding forward-looking statement. 12




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##### Table of Contents



General The Corporation was formed in 1992 and the Bank was formed in 1993.
Subsequently, the Bank has opened offices in several communities in
Southeastern Michigan. The date opened, branch location and branch type of
each branch is listed below: Date Opened
    
    Location
    
    Type of officeFebruary 1994
    
    22290 Michigan Avenue
Dearborn, Michigan 48123
    
    Full service retail branch with ATM
Regional lending centerDecember 1995
    
    24935 West Warren Avenue
Dearborn Heights, Michigan 48127
    
    Full service retail branchAugust 1997
    
    44623 Five Mile Road
Plymouth, Michigan 48170
    
    Full service retail branch with ATMMay 2001
    
    1325 North Canton Center Road
Canton, Michigan 48187
    
    Full service retail branch with ATMDecember 2001
    
    45000 River Ridge Drive
Clinton Township, Michigan 48038
    
    Regional lending centerNovember 2002
    
    19100 Hall Road
Clinton Township, Michigan 48038
    
    Full service retail branch with ATMFebruary 2003
    
    12820 Fort Street
Southgate, Michigan 48195
    
    Full service retail branch with ATMMay 2003
    
    3201 University Drive, Suite 180
Auburn Hills, Michigan 48326
    
    Full service retail branchOctober 2004
    
    450 East Michigan Avenue
Saline, Michigan 48176
    
    Full service retail branch with ATMOctober 2004
    
    2180 West Stadium Boulevard
Ann Arbor, Michigan 48103
    
    Full service retail branch with ATMOctober 2004
    
    250 West Eisenhower, Suite 100
Ann Arbor, Michigan 48103
    
    Regional lending center
 The Bank has also formed three subsidiaries that offer additional or
specialized services to the Banks customers. The Banks subsidiaries, their
formation date and the type of services offered are listed below: Date Formed
    
    Name
    
    Services OfferedAugust 1997
    
    Community Bank Insurance Agency, Inc.
    
    Limited insurance related activitiesMay 2001
    
    Community Bank Mortgage, Inc.
    
    Origination of commercial and
residential mortgage loansMarch 2002
    
    Community Bank Audit Services, Inc.
    
    Internal auditing and compliance
services for financial institutions
 13




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##### Table of Contents



Recent Developments Acquisition of Bank of Washtenaw.On October 29, 2004, the Corporation
acquired the Bank of Washtenaw (Washtenaw), a wholly owned subsidiary of
Pavillion Bancorp, Inc. for $15,100,000 in cash. Washtenaw, which was founded
in January 2001, has its main office in Saline, Michigan with a branch office
and a regional lending center in Ann Arbor, Michigan. As of September 30,
2004, Washtenaw had total assets of $72,147,000, gross loans of $68,406,000 and
total deposits of $64,828,000. Management has not completed the determination
of the fair values of the assets acquired and liabilities assumed or the
identification of amortizable intangibles and goodwill. The following table presents pro forma information for the Corporation
including the acquisition of Bank of Washtenaw for the nine months ended
September 30, 2004 and 2003, as if the acquisition had occurred at the
beginning of 2004 and 2003. The pro forma financial information does not
include adjustments for the amortization of intangibles arising from the
transaction as this analysis has not yet been completed. The pro forma is not
necessarily indicative of the results of operations as they would have been had
the transaction been effected on the assumed dates. (In thousands, except share and per share data)
    
    Nine Months Ended9/30/04
    
    9/30/03Interest income
    
    $
    23,895
    
    
    $
    20,102Interest expense
    
    
    7,419
    
    
    
    7,520Net interest income
    
    
    16,476
    
    
    
    12,582Provision for loan loss
    
    
    893
    
    
    
    1,574Net interest income after provision for loan losses
    
    
    15,583
    
    
    
    11,008Non-interest income
    
    
    1,190
    
    
    
    2,788Non-interest expense
    
    
    10,172
    
    
    
    10,125Income before income tax provision
    
    
    6,601
    
    
    
    3,671Income tax provision
    
    
    2,337
    
    
    
    1,339Net income
    
    $
    4,264
    
    
    $
    2,332Basic earnings per share
    
    $
    1.23
    
    
    $
    0.76Diluted earnings per share
    
    $
    1.12
    
    
    $
    0.70
 14




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##### Table of Contents



Results of Operations The Corporation reported net income of $1,402,000 and $3,966,000 for the three
and nine month periods ended September 30, 2004, compared to net income of
$1,010,000 and $2,349,000 for the three month and nine month periods ended
September 30, 2003. The increase in net income was primarily due to the
improvement in net interest income. The increase in net interest income was
partially offset by the decrease in non-interest income. The improvement in
net interest income was primarily due to the increase in the commercial real
estate loan and other commercial loan portfolios and the decreasing cost of
deposits during the period. The increase in loans was partially funded with
short term investments such as interest bearing deposits with banks, federal
funds sold and floating rate securities, which carry a lower yield than loans. Net Interest Income 2004 Compared to 2003.As noted on the two charts on the following pages, net
interest income for the three and nine month periods ended September 30, 2004
was $5,003,000 and $14,302,000, compared to $4,145,000 and $10,646,000 for the
same periods ended September 30, 2003, an increase of $858,000 or 21% and
$3,656,000 or 34%, respectively. This increase was caused primarily by the
increasing volume of interest earning assets and interest bearing liabilities
and the net interest rate spread between these assets and liabilities. The
Corporations interest rate spread was 3.43% and 3.73% for the three and nine
month periods ended September 30, 2004, compared to 4.17% and 3.61% for the
same periods in 2003. The Corporations interest rate margin was 3.82% and
4.05% for the three and nine month periods ended September 30, 2004, compared
to 4.47% and 3.96% for the same periods in 2003. The net interest rate spread
and net interest margin declined for the three months ended September 30, 2004
due to elevated levels of interest bearing deposits with bank, federal funds
sold and investment securities, available for sale during the period.
Management expects the net interest rate spread and net interest margin will
improve as the funds currently invested in these short term assets are deployed
into loans. The increase in the net interest rate spread and the net interest
margin for the nine months ended September 30, 2004 was primarily due to the
increase in loans and the decreasing cost of interest bearing liabilities. 15




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##### Table of Contents



Average Balances, Interest Rates and Yields.Net interest income is affected
by the difference (interest rate spread) between rates of interest earned on
interest-earning assets and rates of interest paid on interest-bearing
liabilities and the relative amounts of interest-bearing liabilities and
interest-earning assets. When the total of interest-earning assets
approximates or exceeds the total of interest-bearing liabilities, any positive
interest rate spread will generate net interest income. Financial institutions
have traditionally used interest rate spreads as a measure of net interest
income. Another indication of an institutions net interest income is its net
yield on interest-earning assets or net interest margin, which is net
interest income divided by average interest-earning assets. The following tables set forth certain information relating to the
Corporations consolidated average interest-earning assets and interest-bearing
liabilities and reflect the average yield on assets and average cost of
liabilities for the periods indicated. Such yields and costs are derived by
dividing income or expense by the average daily balance of assets or
liabilities, respectively, for the periods presented. During the periods
indicated, non-accruing loans, if any, are included in the loan category. Three months ended
    
    Three months endedSeptember 30, 2004
    
    September 30, 2003Average
    
    
    
    
    
    Average
    
    Average
    
    
    
    
    
    Average(In thousands)
    
    Balance
    
    Interest
    
    Rate
    
    Balance
    
    Interest
    
    RateAssetsInterest-bearing deposits with banks
    
    $
    21,945
    
    
    $
    80
    
    
    
    1.45
    %
    
    $
    434
    
    
    $
    1
    
    
    
    0.92
    %Federal funds sold
    
    
    12,160
    
    
    
    49
    
    
    
    1.60
    %
    
    
    8,359
    
    
    
    18
    
    
    
    0.86
    %Investment securities, available for sale
    
    
    32,214
    
    
    
    155
    
    
    
    1.91
    %
    
    
    14,806
    
    
    
    62
    
    
    
    1.67
    %Loans
    
    
    454,652
    
    
    
    7,142
    
    
    
    6.25
    %
    
    
    345,053
    
    
    
    6,035
    
    
    
    6.96
    %Sub-total earning assets
    
    
    520,971
    
    
    
    7,426
    
    
    
    5.67
    %
    
    
    368,652
    
    
    
    6,116
    
    
    
    6.60
    %Other assets
    
    
    18,235
    
    
    
    
    
    
    
    
    
    
    
    24,089Total assets
    
    $
    539,206
    
    
    
    
    
    
    
    
    
    
    $
    392,741Liabilities and stockholders equityInterest bearing deposits
    
    $
    400,265
    
    
    $
    2,080
    
    
    
    2.07
    %
    
    $
    291,597
    
    
    $
    1,613
    
    
    
    2.20
    %Other borrowings
    
    
    30,634
    
    
    
    343
    
    
    
    4.45
    %
    
    
    30,657
    
    
    
    358
    
    
    
    4.65
    %Sub-total interest bearing liabilities
    
    
    430,899
    
    
    
    2,423
    
    
    
    2.24
    %
    
    
    322,254
    
    
    
    1,971
    
    
    
    2.43
    %Non-interest bearing deposits
    
    
    43,553
    
    
    
    
    
    
    
    
    
    
    
    35,598Other liabilities
    
    
    1,711
    
    
    
    
    
    
    
    
    
    
    
    1,530Stockholders equity
    
    
    63,043
    
    
    
    
    
    
    
    
    
    
    
    33,188Total liabilities and stockholders equity
    
    $
    539,206
    
    
    
    
    
    
    
    
    
    
    $
    392,741Net interest income
    
    
    
    
    
    $
    5,003
    
    
    
    
    
    
    
    
    
    
    $
    4,145Net interest rate spread
    
    
    
    
    
    
    
    
    
    
    3.43
    %
    
    
    
    
    
    
    
    
    
    
    4.17
    %Net interest margin on earning assets
    
    
    
    
    
    
    
    
    
    
    3.82
    %
    
    
    
    
    
    
    
    
    
    
    4.47
    %
 16




---



##### Table of Contents



Nine months ended
    
    Nine months endedSeptember 30, 2004
    
    September 30, 2003Average
    
    
    
    
    
    Average
    
    Average
    
    
    
    
    
    Average(In thousands)
    
    Balance
    
    Interest
    
    Rate
    
    Balance
    
    Interest
    
    RateAssetsInterest-bearing deposits with banks
    
    $
    9,842
    
    
    $
    97
    
    
    
    1.32
    %
    
    $
    14,707
    
    
    $
    131
    
    
    
    1.19
    %Federal funds sold
    
    
    9,511
    
    
    
    87
    
    
    
    1.22
    %
    
    
    11,841
    
    
    
    97
    
    
    
    1.10
    %Investment securities, available for sale
    
    
    20,978
    
    
    
    293
    
    
    
    1.87
    %
    
    
    23,085
    
    
    
    450
    
    
    
    2.61
    %Loans
    
    
    431,617
    
    
    
    20,296
    
    
    
    6.28
    %
    
    
    311,112
    
    
    
    16,487
    
    
    
    7.10
    %Sub-total earning assets
    
    
    471,948
    
    
    
    20,773
    
    
    
    5.88
    %
    
    
    360,745
    
    
    
    17,165
    
    
    
    6.38
    %Other assets
    
    
    16,929
    
    
    
    
    
    
    
    
    
    
    
    23,206Total assets
    
    $
    488,877
    
    
    
    
    
    
    
    
    
    
    $
    383,951Liabilities and stockholders equityInterest bearing deposits
    
    $
    371,193
    
    
    $
    5,443
    
    
    
    1.96
    %
    
    $
    284,667
    
    
    $
    5,456
    
    
    
    2.57
    %Other borrowings
    
    
    30,636
    
    
    
    1,028
    
    
    
    4.48
    %
    
    
    30,659
    
    
    
    1,063
    
    
    
    4.65
    %Sub-total interest bearing liabilities
    
    
    401,829
    
    
    
    6,471
    
    
    
    2.15
    %
    
    
    315,326
    
    
    
    6,519
    
    
    
    2.77
    %Non-interest bearing deposits
    
    
    40,559
    
    
    
    
    
    
    
    
    
    
    
    34,978Other liabilities
    
    
    1,229
    
    
    
    
    
    
    
    
    
    
    
    1,523Stockholders equity
    
    
    45,260
    
    
    
    
    
    
    
    
    
    
    
    32,124Total liabilities and stockholders equity
    
    $
    488,877
    
    
    
    
    
    
    
    
    
    
    $
    383,951Net interest income
    
    
    
    
    
    $
    14,302
    
    
    
    
    
    
    
    
    
    
    $
    10,646Net interest rate spread
    
    
    
    
    
    
    
    
    
    
    3.73
    %
    
    
    
    
    
    
    
    
    
    
    3.61
    %Net interest margin on earning assets
    
    
    
    
    
    
    
    
    
    
    4.05
    %
    
    
    
    
    
    
    
    
    
    
    3.96
    %
 17




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##### Table of Contents



Rate/Volume Analysis.The following table analyzes net interest income in
terms of changes in the volume of interest-earning assets and interest-bearing
liabilities and changes in yields and rates. The table reflects the extent to
which changes in the interest income and interest expense are attributable to
changes in volume (changes in volume multiplied by prior year rate) and changes
in rate (changes in rate multiplied by prior year volume). Changes
attributable to the combined impact of volume and rate have been allocated
proportionately to changes due to volume and changes due to rate. Three Months Ended
    
    Nine Months EndedSeptember 30, 2004/2003
    
    September 30, 2004/2003Change in Interest Due to:
    
    Change in Interest Due to:Average
    
    Average
    
    Net
    
    Average
    
    Average
    
    Net(In thousands)
    
    Balance
    
    Rate
    
    Change
    
    Balance
    
    Rate
    
    ChangeAssetsInterest bearing deposits with banks
    
    $
    78
    
    
    $
    1
    
    
    $
    79
    
    
    
    ($43
    )
    
    $
    9
    
    
    
    ($34
    )Federal funds sold
    
    
    15
    
    
    
    16
    
    
    
    31
    
    
    
    (17
    )
    
    
    7
    
    
    
    (10
    )Investment securities, available for sale
    
    
    84
    
    
    
    9
    
    
    
    93
    
    
    
    (74
    )
    
    
    (83
    )
    
    
    (157
    )Loans
    
    
    1,718
    
    
    
    (611
    )
    
    
    1,107
    
    
    
    5,082
    
    
    
    (1,273
    )
    
    
    3,809Total earning assets
    
    $
    1,895
    
    
    
    ($585
    )
    
    $
    1,310
    
    
    $
    4,947
    
    
    
    ($1,339
    )
    
    $
    3,608LiabilitiesInterest bearing deposits
    
    $
    564
    
    
    
    ($97
    )
    
    $
    467
    
    
    $
    857
    
    
    
    ($870
    )
    
    
    ($13
    )Other borrowings
    
    
    
    
    
    
    (15
    )
    
    
    (15
    )
    
    
    
    
    
    
    (35
    )
    
    
    (35
    )Total interest bearing liabilities
    
    $
    564
    
    
    
    ($112
    )
    
    $
    452
    
    
    $
    857
    
    
    
    ($905
    )
    
    
    ($48
    )Net interest income
    
    
    
    
    
    
    
    
    
    $
    858
    
    
    
    
    
    
    
    
    
    
    $
    3,656Net interest rate spread
    
    
    
    
    
    
    
    
    
    
    (0.73
    %)
    
    
    
    
    
    
    
    
    
    
    0.12
    %Net interest margin on earning assets
    
    
    
    
    
    
    
    
    
    
    (0.65
    %)
    
    
    
    
    
    
    
    
    
    
    0.09
    %
 Provision for Loan Losses 2004 Compared to 2003.The provision for loan losses was $369,000 and $874,000
for the three and nine month periods ended September 30, 2004, compared to
$671,000 and $1,410,000 for the same periods in 2003, a decrease of $302,000 or
45% for the three month period and $536,000 or 38% for the nine month period.
The decrease is primarily due to the decrease in net charge-offs during the
nine months ended September 30, 2004 compared to the nine month period ended
September 30, 2003. The provision for loan losses for the three and nine month
periods ended September 30, 2004 is based on the internal analysis of the
adequacy of the allowance for loan losses. The provision for loan losses was
based upon managements assessment of relevant factors, including types and
amounts of non-performing loans, historical and anticipated loss experience on
such types of loans, and current economic conditions. 18




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##### Table of Contents



Non-interest Income 2004 Compared to 2003.Non-interest income was $246,000 and $971,000 for the
three and nine month periods ended September 30, 2004, compared to $772,000 and
$2,429,000 for the same periods in 2003, a decrease of $526,000 or 68% for the
three month period and $1,458,000 or 60% for the nine month period. The
decrease was primarily due to the decrease in the gain on the sale of loans
during the period. The volume of mortgage loans sold decreased during the
period as a result of increased interest rates and a decrease in the size of
the mortgage origination staff. Management expects the gain on sale of loans
to continue at current levels during 2004. Non-interest Expense 2004 Compared to 2003.Non-interest expense was $2,755,000 and $8,394,000 for
the three and nine month periods ended September 30, 2004, compared to
$2,721,000 and $8,113,000 for the same periods in 2003, an increase of $34,000
or 1% for the three month period and $281,000 or 3% for the nine month period.
The largest component of non-interest expense was salaries and employee
benefits which amounted to $1,868,000 and $5,537,000 for the three and nine
month periods ended September 30, 2004, compared to $1,534,000 and $4,579,000
for the same periods in 2003, an increase of $334,000 or 22% for the three
month period and $958,000 or 21% for the six month period. The primary factors
for the increase in salaries and benefits expense was the expansion of the
commercial lending, retail administration and operations departments. As of
September 30, 2004, the number of full time equivalent employees was 119
compared to 112 as of September 30, 2003. Salaries and employee benefits will
continue to increase due to the acquisition of the Bank of Washtenaw and
general staff increases. Commissions on the origination of loans amounted to $52,000 and $202,000 for
the three and nine month periods ended September 30, 2004, compared to $253,000
and $814,000 for the same periods in 2003, a decrease of $201,000 or 79% for
the three month period and $612,000 or 75% for the nine month period. The
primary reason for the decrease in the commissions on the origination of loans
was the decrease in the volume of loans originated during the period.
Management expects the commissions paid on the origination of loans to continue
at current levels during 2004. The second largest component of non-interest expense was occupancy and
equipment expense. Occupancy and equipment expense amounted to $322,000 for
the three month period ended September 30, 2004, compared to $369,000 for the
same period in 2003, a decrease of $47,000 or 13% for the three month period.
Occupancy and equipment expense amounted to $1,046,000 for the nine month
period ended September 30, 2004, compared to $1,040,000 for the same period in
2003, an increase of $6,000 or 1% for the three month period. Income Tax Provision 2004 Compared to 2003.The income tax expense was $723,000 and $2,039,000 for
the three and nine month periods ended September 30, 2004, compared to $515,000
and $1,203,000 for the same periods in 2003, an increase of $208,000 or 40% for
the three month period and $836,000 or 69% for the nine month period. The
increase was primarily a result of increased pre-tax income. 19




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##### Table of Contents



Comparison of Financial Condition at September 30, 2004 and December 31, 2003 Assets.Total assets at September 30, 2004 were $574,093,000 compared to
$446,075,000 at December 31, 2003, an increase of $128,018,000 or 29%. The
increase was primarily due to the increase in loans, securities, available for
sale, federal funds sold and interest bearing deposits with banks during the
period. Federal Funds Sold.Total federal funds sold at September 30, 2004 were
$11,636,000 compared to $7,651,000 at December 31, 2003, an increase of
$3,985,000 or 52%. The increase was primarily due to the short term deployment
of funds that were received as a result of an increase in deposits. Available
funds are deployed into federal funds sold until they can be utilized to fund
loan volume. Interest bearing deposits with banks.Total interest bearing deposits with
banks at September 30, 2004 were $29,600,000 compared to $8,325,000 at December
31, 2003, an increase of $21,275,000 or 256%. This investment was established
to provide the Corporation with an alternate short term investment option.
This short term investment is a variable-rate certificate of deposit with the
Federal Home Loan Bank of Indianapolis that carries a similar rate of return to
federal funds sold. Available funds are deployed into interest bearing
deposits with banks until they can be utilized to fund loan volume. Mortgage Loans Held for Sale.Total mortgage loans held for sale at September
30, 2004 were $1,533,000 compared to $1,505,000 at December 31, 2003, an
increase of $28,000 or 2%. This increase was a result of the increase in the
level of residential real estate mortgage loans waiting to be purchased by
mortgage correspondents. Securities  Available for Sale.Total securities, available for sale, at
September 30, 2004 were $39,516,000 compared to $16,948,000 at December 31,
2003, an increase of $22,568,000 or 133%. The increase was due to investment
of funds received from the sale of common stock on July 23, 2004. These funds
will be invested in securities, available for sale until they need to be
deployed to the Bank in anticipation for future growth or utilized for other
general corporate purposes. Please refer to Note B of the Notes to Consolidated Financial Statements for
the amortized cost and estimated market value of securities, available for
sale. Federal Home Loan Bank Stock.Federal Home Loan Bank stock was valued at
$1,111,000 at September 30, 2004, compared to $1,073,000 at December 31, 2003,
an increase of $38,000 or 4%. 20




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##### Table of Contents



Loans.Total loans at September 30, 2004 were $474,111,000 compared to
$400,958,000 at December 31, 2003, an increase of $73,153,000 or 18%. The
increase was primarily due to the continued expansion of the commercial
lending department during the past twelve months. This expansion included the
addition of two experienced loan officers during the last twelve months.
Major categories of loans included in the loan portfolio are as follows (in
thousands): 09/30/04
    
    12/31/03
    
    09/30/03Consumer loans
    
    $
    27,199
    
    
    $
    25,200
    
    
    $
    23,476Commercial, financial & other
    
    
    87,912
    
    
    
    68,922
    
    
    
    64,969Commercial real estate construction
    
    
    57,098
    
    
    
    50,087
    
    
    
    46,872Commercial real estate mortgages
    
    
    255,378
    
    
    
    208,305
    
    
    
    196,798Residential real estate mortgages
    
    
    46,524
    
    
    
    48,444
    
    
    
    42,848474,111
    
    
    
    400,958
    
    
    
    374,963Allowance for loan losses
    
    
    (5,188
    )
    
    
    (4,314
    )
    
    
    (4,016
    )$
    468,923
    
    
    $
    396,644
    
    
    $
    370,947
 The following is a summary of non-performing assets and problems loans (in
thousands): 09/30/04
    
    12/31/03
    
    09/30/03Over 90 days past due and still accruing
    
    $
    4
    
    
    $
    19
    
    
    $
    241Non-accrual loans
    
    
    1,542
    
    
    
    2,056
    
    
    
    2,103Other real estate owned
    
    
    357
    
    
    
    
    
    
    
    $
    1,903
    
    
    $
    2,075
    
    
    $
    2,344
 Non-accrual loans at September 30, 2004 were $1,542,000, of which, $791,000
was related to one commercial loan relationship that is well secured. The
remaining non-accrual loans consisted of one slow-paying home equity loan with
a balance of $28,000, one slow-paying construction loan with a balance of
$525,000 and two well-secured residential mortgage loans with balances of
$82,000 and $116,000. Allowance for Loan Losses.The allowance for loan losses was $5,188,000 at
September 30, 2004 compared to $4,314,000 at December 31, 2003, an increase of
$874,000 or 20%. The increase resulted from provisions for loan losses
recorded during the nine months ended September 30, 2004 and a net recovery of
$1,000 during the nine months ended September 30, 2004 and responds to the
growth of the loan portfolio as well as the mix of loans and levels of
nonperforming loans. The allowance for loan losses was based upon managements
assessment of relevant factors, including loan growth, types and amounts of
non-performing loans, historical and anticipated loss experience on such types
of loans, and current economic conditions. 21




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##### Table of Contents



The following is an analysis of the allowance for loan losses (in thousands): Nine Months
    
    
    
    
    
    Nine MonthsEnded
    
    Year Ended
    
    Ended09/30/04
    
    12/31/03
    
    09/30/03Balance, beginning of year
    
    $
    4,314
    
    
    $
    2,875
    
    
    $
    2,875Charge-offs:Consumer loans
    
    
    19
    
    
    
    38
    
    
    
    38Commercial, financial & other
    
    
    
    
    
    
    141
    
    
    
    139Commercial real estate construction
    
    
    
    
    
    
    50
    
    
    
    50Commercial real estate mortgages
    
    
    
    
    
    
    124
    
    
    
    70Residential real estate mortgages
    
    
    94
    
    
    
    
    
    
    
    Recoveries:Consumer loans
    
    
    12
    
    
    
    13
    
    
    
    11Commercial, financial & other
    
    
    41
    
    
    
    30
    
    
    
    17Commercial real estate construction
    
    
    
    
    
    
    50
    
    
    
    Commercial real estate mortgages
    
    
    61
    
    
    
    
    
    
    
    Residential real estate mortgages
    
    
    
    
    
    
    
    
    
    
    Net charge-offs
    
    
    (1
    )
    
    
    260
    
    
    
    269Additions charged to operations
    
    
    873
    
    
    
    1,699
    
    
    
    1,410Balance, end of period
    
    $
    5,188
    
    
    $
    4,314
    
    
    $
    4,016Allowance to total loans
    
    
    1.09
    %
    
    
    1.08
    %
    
    
    1.07
    %Allowance to nonperforming assets
    
    
    272.67
    %
    
    
    207.90
    %
    
    
    172.27
    %Net charge-offs to average loans
    
    
    0.00
    %
    
    
    0.08
    %
    
    
    0.08
    %
 Premises and Equipment.Bank premises and equipment at September 30, 2004 was
$10,987,000 compared to $5,554,000 at December 31, 2003, an increase of
$5,433,000 or 98 %. The increase in premises and equipment was primarily due
to the purchase and renovation of the Banks operation center in Allen Park,
Michigan and the Banks administrative center in Dearborn, Michigan. The
operations center will house the Banks accounting, data operations, mortgage
operations, product support, compliance and audit functions. The Banks
executive, commercial lending and human resources functions will be located
within the administrative center. Both facilities will be occupied during the
fourth quarter of 2004. 22




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##### Table of Contents



Real Estate Owned.Real estate owned at September 30, 2004 was $357,000
compared to $0 at December 31, 2003. The increase was due to the Banks
foreclosure of one commercial loan, which was collateralized by three
residential properties and one residential mortgage loan. The book values and
appraised values of the real estate owned are as follows: ESTIMATEDPOSSESSION
    
    MARKET
    
    BOOKPROPERTY ADDRESS
    
    DATE
    
    VALUE
    
    VALUEResidential House
Hazel Park, MI
    
    05/19/04
    
    
    95,000Residential Condominium
Madison Heights, MI
    
    04/28/04
    
    
    92,000Residential Condominium
Madison Heights, MI
    
    04/28/04
    
    
    90,000277,000
    
    
    
    207,395Residential House
Spring Arbor, MI
    
    07/01/04
    
    
    150,000
    
    
    
    150,000Total real estate owned
    
    
    
    $
    427,000
    
    
    $
    357,395
 Accrued Interest Receivable.Accrued interest receivable at September 30, 2004
was $1,648,000 compared to $1,461,000 at December 31, 2003, an increase of
$187,000 or 13%. The increase was primarily due to the increase in loans. Other Assets. Other assets at September 30, 2004 were $2,439,000 compared to
$1,742,000 at December 31, 2003, an increase of $697,000 or 40%. The increase
was primarily due to changes in deferred tax assets. 23




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##### Table of Contents



Deposits.Total deposits at September 30, 2004 were $469,014,000 compared to
$379,619,000 at December 31, 2003, an increase of $89,395,000 or 24%. The
following is a summary of the distribution of deposits (in thousands): 09/30/04
    
    12/31/03
    
    09/30/03Non-interest bearing:Demand
    
    $
    45,136
    
    
    $
    39,081
    
    
    $
    36,032Interest bearing:Checking
    
    $
    14,988
    
    
    $
    24,069
    
    
    $
    22,107Money market
    
    
    34,336
    
    
    
    10,998
    
    
    
    11,958Savings
    
    
    91,611
    
    
    
    126,596
    
    
    
    116,862Time, under $100,000
    
    
    99,620
    
    
    
    65,120
    
    
    
    65,402Time, $100,000 and over
    
    
    183,323
    
    
    
    113,755
    
    
    
    91,464423,878
    
    
    
    340,538
    
    
    
    307,793Total deposits
    
    $
    469,014
    
    
    $
    379,619
    
    
    $
    343,825
 Management continues to implement a strategy to change the mix of the deposit
portfolio by focusing more heavily on savings and institutional deposits. The
increase in deposits was primarily due to normal business development,
marketing, telemarketing, referral programs and growth strategies which
included a promotion that celebrated the Banks 10th Anniversary during March
2004, which targeted time deposit growth. Management expects deposits to
continue to grow at a similar rate during the remainder of 2004. The Bank has enacted a strategy to utilize public funds to a higher degree.
The Bank will also utilize brokered deposits. The Bank has designated a public
funds officer to coordinate and manage these efforts. Public funds consist of
interest checking and time deposits of local governmental units. They are the
result of strong relationships between the Bank and the communities in the
Banks marketing area and are considered by the Bank to be core deposits. The
following is a summary of the distribution of municipal deposits (in
thousands): 09/30/04
    
    12/31/03
    
    09/30/03Interest bearing checking
    
    $
    5,047
    
    
    $
    14,419
    
    
    $
    12,642Time, $100,000 and over
    
    
    77,044
    
    
    
    46,580
    
    
    
    29,935Total municipal deposits
    
    $
    82,091
    
    
    $
    60,999
    
    
    $
    42,577
 Brokered deposits are included in the Time, $100,000 and over category.
Brokered deposits were $14,190,000, $1,330,000 and $100,000 at September 30,
2004, December 31, 2003 and September 30, 2003, respectively. 24




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##### Table of Contents



Federal Home Loan Bank Advances. Federal Home Loan Bank advances at September
30, 2004 were $20,614,000 compared to $20,638,000 at December 31, 2003, a
decrease of $24,000 or 0%. This decrease was due to a scheduled principal
payment on one Federal Home Loan Bank advance. Other Liabilities. Other liabilities at September 30, 2004 were $1,140,000
compared to $463,000 at December 31, 2003, an increase of $677,000 or 146%.
The increase was primarily due to the increase in expenses payable during the
period. Accrued Interest Payable. Accrued interest payable at September 30, 2004 was
$928,000 compared to $754,000 at December 31, 2003, an increase of $174,000 or
23%. The increase was primarily due to the increasing amount of interest
bearing deposits during the period. Subordinated Debentures. Subordinated debentures were $10,000,000 at September
30, 2004 and December 31, 2003.On December 19, 2002, the Corporation issued
$10,000,000 of floating rate obligated mandatory redeemable securities through
a special purpose entity as part of a pooled offering. The securities have a
term of thirty years. The Corporation may redeem the securities after five
years at face value. They are considered to be Tier 1 capital for regulatory
capital purposes. The funds from the issue of these securities were invested
into the Bank to allow for additional growth. Debt issue costs of $300,000
have been capitalized and are being amortized over the term of the securities.
Unamortized debt issuance costs were $282,000 at September 30, 2004. 25




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##### Table of Contents



Capital Stockholders equity at September 30, 2004 was $72,397,000 compared to
$34,601,000 as of December 31, 2003, an increase of $37,796,000 or 109%. The
increase was primarily due the sale of 1,265,000 shares of its common stock at
$26.00 per share in a firm commitment underwritten offering lead managed by
Oppenheimer & Co., Inc. and co-managed by Howe Barnes Investments, Inc.
Additionally, the underwriters exercised an option to purchase 135,871
additional shares of common stock from the Company solely to cover
over-allotments. The offering was priced on July 19, 2004 and closed on July
23, 2004. The net proceeds of the sale of common stock were $34,237,000. The
Corporation intends to use $15 million of the net proceeds for the acquisition
of the Bank of Washtenaw on October 29, 2004. The Corporation will use the
remaining net proceeds to increase the Banks capital position in anticipation
of future growth, and for other general corporate purposes. The following is a presentation of the Corporations and Banks regulatory
capital ratios (in thousands): MinimumTo Be Well CapitalizedMinimum for Capital
    
    Under Prompt CorrectiveActual
    
    Adequacy Purposes
    
    Action ProvisionsAmount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    RatioAs of September 30, 2004Total capital(to risk weighted assets)Consolidated
    
    
    87,775
    
    
    
    16.84
    %
    
    
    41,692
    
    
    
    8.00
    %
    
    
    52,115
    
    
    
    10.00
    %Bank
    
    
    51,630
    
    
    
    10.07
    %
    
    
    41,031
    
    
    
    8.00
    %
    
    
    51,289
    
    
    
    10.00
    %Tier 1 capital(to risk weighted assets)Consolidated
    
    
    82,587
    
    
    
    15.85
    %
    
    
    20,846
    
    
    
    4.00
    %
    
    
    31,269
    
    
    
    6.00
    %Bank
    
    
    46,442
    
    
    
    9.06
    %
    
    
    20,515
    
    
    
    4.00
    %
    
    
    30,773
    
    
    
    6.00
    %Tier 1 capital(to average assets)Consolidated
    
    
    82,587
    
    
    
    15.32
    %
    
    
    21,568
    
    
    
    4.00
    %
    
    
    26,960
    
    
    
    5.00
    %Bank
    
    
    46,442
    
    
    
    9.07
    %
    
    
    20,472
    
    
    
    4.00
    %
    
    
    25,589
    
    
    
    5.00
    %As of December 31, 2003Total capital(to risk weighted assets)Consolidated
    
    
    48,893
    
    
    
    11.80
    %
    
    
    33,237
    
    
    
    8.00
    %
    
    
    41,547
    
    
    
    10.00
    %Bank
    
    
    42,763
    
    
    
    10.50
    %
    
    
    32,701
    
    
    
    8.00
    %
    
    
    40,877
    
    
    
    10.00
    %Tier 1 capital(to risk weighted assets)Consolidated
    
    
    44,579
    
    
    
    10.70
    %
    
    
    16,639
    
    
    
    4.00
    %
    
    
    24,928
    
    
    
    6.00
    %Bank
    
    
    38,449
    
    
    
    9.40
    %
    
    
    16,351
    
    
    
    4.00
    %
    
    
    24,526
    
    
    
    6.00
    %Tier 1 capital(to average assets)Consolidated
    
    
    44,579
    
    
    
    10.20
    %
    
    
    17,460
    
    
    
    4.00
    %
    
    
    21,825
    
    
    
    5.00
    %Bank
    
    
    38,449
    
    
    
    9.00
    %
    
    
    17,113
    
    
    
    4.00
    %
    
    
    21,391
    
    
    
    5.00
    %
 Based on the respective regulatory capital ratios at September 30, 2004 and
December 31, 2003, the Corporation and Bank are considered well capitalized. 26




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##### Table of Contents



PART I    FINANCIAL INFORMATION 
 ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
                     RISK Interest Rate Sensitivity Analysis.The Corporation has sought to manage its
exposure to changes in interest rates by matching the effective maturities or
repricing characteristics of the Corporations interest-earning assets and
interest-bearing liabilities. The matching of the assets and liabilities may
be analyzed by examining the extent to which the assets and liabilities are
interest rate sensitive and by monitoring the expected effects of interest rate
changes on net interest income. An asset or liability is interest rate sensitive within a specific time period
if it will mature or reprice within that time period. If the Corporations
assets mature or reprice more quickly or to a greater extent that its
liabilities, the Corporations net portfolio value and net interest income
would tend to increase during periods of rising interest rates but decrease
during periods of falling interest rates. If the Corporations assets mature
or reprice more slowly or to a lesser extent than its liabilities, its net
portfolio value and net interest income would tend to decrease during periods
of rising interest rates but increase during periods of falling interest rates. The matching of assets and liabilities may be analyzed by examining the extent
to which such assets and liabilities are interest rate sensitive and by
monitoring an institutions interest rate sensitivity gap. An asset or
liability is said to be interest rate sensitive within a specific period if it
will mature or reprice within that period. The interest rate sensitivity gap
is the difference between the amount of interest-earning assets maturing or
repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within that time period. A gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount
of interest rate sensitive liabilities, and is considered negative when the
amount of interest rate sensitive liabilities exceed the amount of interest
rate sensitive assets. During a period of rising interest rates, a negative
gap would be expected to adversely affect net interest income while a positive
gap would be expected to result in an increase in net interest income, while
conversely during a period of declining interest rates, a negative gap would be
expected to result in an increase in net interest income and a positive gap
would be expected to adversely affect net interest income. 27




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##### Table of Contents



Different types of assets and liabilities with the same or similar maturities
may react differently to changes in overall market rates or conditions, and
thus changes in interest rates may affect net interest income positively or
negatively even if an institution were perfectly matched in each maturity
category. Additionally, the gap analysis does not consider the many factors as
banking interest rates move. While the interest rate sensitivity gap is a
useful measurement and contributes toward effective asset and liability
management, it is difficult to predict the effect of changing interest rates
solely on that measure, without accounting for alterations in the maturity or
repricing characteristics of the balance sheet that occur during changes in
market interest rates.
During periods of rising interest rates, the Corporations assets tend to have
prepayments that are slower than those in an interest rate sensitivity gap and
would increase the negative gap position. Conversely, during a period of
declining interest rates, the Corporations assets would tend to prepay faster
than originally expected thus decreasing the negative gap position. In
addition, some of the Corporations assets, such as adjustable rate mortgages,
have caps on the amount by which their interest rates can change in any single
period, and therefore may not reprice as quickly as liabilities in the same
maturity category. The following table sets forth the amounts of interest earning assets and
interest bearing liabilities outstanding at September 30, 2004, which are
expected to mature or reprice in each of the time periods shown below. Interest Rate Sensitivity Period(In thousands)
    
    1-90
    
    91-365
    
    1-5
    
    OverDays
    
    Days
    
    Years
    
    5 Years
    
    TotalEarning assetsFederal funds sold
    
    $
    11,636
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    11,636Interest bearing deposits with
Banks
    
    
    29,600
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29,600Mortgage loans held for sale
    
    
    1,533
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,533Securities available for sale
    
    
    24,536
    
    
    
    9,416
    
    
    
    4,724
    
    
    
    840
    
    
    
    39,516Federal Home Loan Bank stock
    
    
    1,111
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,111Total loans, net of non-accrual
    
    
    205,560
    
    
    
    19,706
    
    
    
    232,305
    
    
    
    14,998
    
    
    
    472,569Total earning assets
    
    
    273,976
    
    
    
    29,122
    
    
    
    237,029
    
    
    
    15,838
    
    
    
    555,965Interest bearing liabilitiesTotal interest bearing deposits
    
    
    215,171
    
    
    
    122,423
    
    
    
    86,284
    
    
    
    
    
    
    
    423,878Federal Home Loan Bank advances
    
    
    
    
    
    
    10,000
    
    
    
    10,614
    
    
    
    
    
    
    
    20,614Trust preferred securities
    
    
    10,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,000Total interest bearing liabilities
    
    
    225,171
    
    
    
    132,423
    
    
    
    96,898
    
    
    
    
    
    
    
    454,492Net asset (liability) funding gap
    
    
    48,805
    
    
    
    (103,301
    )
    
    
    140,131
    
    
    
    15,838
    
    
    $
    101,473Cumulative net asset (liability) funding
gap
    
    $
    48,805
    
    
    
    ($54,496
    )
    
    $
    85,635
    
    
    $
    101,473
 28




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##### Table of Contents



Liquidity.Liquidity refers to readily available funds to meet the needs of
borrowers and depositors. Levels of liquidity are closely monitored in
conjunction with loan funding requirements and deposit outflows. Adequate
liquidity protects institutions from raising funds under duress at excessive
expense and provides a necessary cushion for occasional unpredictable
aberrations in demand. While adequate liquidity is imperative, excessive
liquidity in lower yielding cash investments or other easily marketable assets
reduces potential interest income. Thus, an appropriate balance must be
maintained to protect the institution and at the same time, prudently maximize
income opportunities. Sources of liquidity from both assets and liabilities
include federal funds sold, securities available for sale, loan repayments,
core deposits, Federal Home Loan Bank advances and a federal funds purchase
credit facility. The following tables provide information about the Banks contractual
obligations and commitments at September 30, 2004 (in thousands): Contractual Obligations Payments Due By Period1-3
    
    3-5
    
    Over 5Less Than 1 Year
    
    Years
    
    Years
    
    Years
    
    TotalLong-term borrowings
    
    $
    25
    
    
    $
    10,589
    
    
    $
    10,000
    
    
    $
    
    
    
    $
    20,614Lease commitments
    
    
    362
    
    
    
    732
    
    
    
    641
    
    
    
    642
    
    
    
    2,377Subordinated debentures
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,000
    
    
    
    10,000Totals
    
    $
    387
    
    
    $
    11,321
    
    
    $
    10,641
    
    
    $
    10,642
    
    
    $
    32,991
 Unused Loan Commitments and Letters of Credit Amount Of Commitment Expiration Per Period1-3
    
    3-5
    
    Over 5Less Than 1 Year
    
    Years
    
    Years
    
    Years
    
    TotalUnused loan commitments
    
    $
    58,371
    
    
    $
    15,652
    
    
    $
    1,335
    
    
    $
    16,238
    
    
    $
    91,596Standby letters of credit
    
    
    2,226
    
    
    
    
    
    
    
    3,000
    
    
    
    
    
    
    
    5,226Totals
    
    $
    60,597
    
    
    $
    15,652
    
    
    $
    4,335
    
    
    $
    16,238
    
    
    $
    96,822
 29




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##### Table of Contents



Item 4. Controls and Procedures Disclosure Controls and Procedures As of the end of the period covered by
this report, the registrant carried out an evaluation, under the supervision
and with the participation of management, including the Chief Executive Officer
and the Chief Financial Officer, of the effectiveness of the design and
operation of the registrants disclosure controls and procedures. Based on the
review of the disclosure controls of the registrant, the Chief Executive
Officer and the Chief Financial Officer have concluded that the registrants
disclosure controls and procedures are effective in timely alerting them to the
material information relating to the registrant that is required to be included
in the periodic SEC filings. Internal Controls Over Financial Reporting  There has been no change in the
registrants internal control over financial reporting that occurred during the
period covered by this report that has materially affected, or is reasonably
likely to materially affect the registrants internal control over financial
reporting. 30




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PART II    OTHER INFORMATION 
 ITEM 6. EXHIBITS AND REPORTS IN FORM 8-K. (a)
    
    ExhibitsExhibit 31.1
    
    CEO Certification. pursuant to Section 302 of the Sarbanes-Oxley Act of 
2002.Exhibit 31.2
    
    CFO Certification. pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.Exhibit 32.1
    
    CEO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 
2002.Exhibit 32.2
    
    CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.(b)
    
    Two Form 8-K Reports, dated July 23, 2004 and August 24, 2004 were filed during thequarter ended September 30, 2004.
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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. Dearborn Bancorp, Inc.
     (Registrant)/s/ John E. DemmerJohn E. DemmerChairman /s/ Michael J. RossMichael J. RossPresident and Chief Executive Officer /s/ Jeffrey L. KarafaJeffrey L. KarafaTreasurer and Chief Financial Officer Date: November 10, 2004 32




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EXHIBIT INDEX EXHIBIT NO.
    
    DESCRIPTIONEX  31.1
    
    Certification of Chief Executive Officer pursuant to Section 302EX  31.2
    
    Certification of Chief Financial Officer pursuant to Section 302EX  32.1
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002EX  32.2
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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