e8vk

-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QZkoPK2s6nfBroyNPkwZQsdIO9DiSaIzu7YTvpWmwhD44yJm7hc7qi875DOSeN/e vcTxigBzRfa6uT87UT3KcA== 0000893220-05-002821.txt : 20051205 0000893220-05-002821.hdr.sgml : 20051205 20051205170305 ACCESSION NUMBER: 0000893220-05-002821 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20051205 ITEM INFORMATION: Other Events ITEM INFORMATION: Financial Statements and Exhibits FILED AS OF DATE: 20051205 DATE AS OF CHANGE: 20051205 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FULTON FINANCIAL CORP CENTRAL INDEX KEY: 0000700564 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 232195389 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-10587 FILM NUMBER: 051244827 BUSINESS ADDRESS: STREET 1: ONE PENN SQ STREET 2: PO BOX 4887 CITY: LANCASTER STATE: PA ZIP: 17604 BUSINESS PHONE: 7172912411 MAIL ADDRESS: STREET 1: ONE PENN SQ STREET 2: PO BOX 4887 CITY: LANCASTER STATE: PA ZIP: 17604 8-K 1 w15301e8vk.htm FORM 8-K FULTON FINANCIAL CORPORATION e8vk

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20459

FORM 8-K

CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934

Date of Report (Date of earliest event reported): December 5, 2005

FULTON FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)


Pennsylvania	0-010587	23-2195389

(State or other jurisdiction	(Commission File	(IRS Employer
of incorporation)	Number)	Identification Number)


One Penn Square, P.O. Box 4887, Lancaster, Pennsylvania		17604

(Address of principal executive offices)		(Zip Code)

(717) 291-2411

(Registrant’s telephone number, including area code)

Not Applicable

(Former name or former address, if changed since last report)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:

o Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

o Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

o Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

o Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

ITEM 8.01 OTHER EVENTS

As previously disclosed, Fulton Financial Corporation (the Corporation) adopted Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (Statement 123R) in the quarter ended September 30, 2005. Statement 123R requires that the fair value of equity awards to employees be recognized as compensation expense over the period during which an employee is required to provide service in exchange for such award. The Corporation elected to adopt Statement 123R using “modified retrospective application”, which requires restatement of previously reported financial information.

Fulton is filing the historical annual and quarterly financial information included in this Current Report on Form 8-K to show the effects on prior periods of the adoption of Statement 123R using modified retrospective application. Such results are consistent with the previously reported pro forma disclosures required under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation”, which preceded Statement 123R. The treatment of stock-based compensation was appropriate in Fulton’s prior filings with the Securities and Exchange Commission, as the provisions of Statement 123R were not adopted until subsequent to the original filings; therefore, the filing of this Form 8-K is not an amendment to such filings. Except as specifically set forth in the Exhibits to this Current Report, the information in the Exhibits hereto does not reflect any other events occurring after Fulton filed its Form 10-K on March 16, 2005 for the year ended December 31, 2004. For a discussion of events and developments subsequent to March 16, 2005, please refer to the reports and other information that Fulton has filed with the Securities and Exchange Commission.

The Corporation declared a 5-for-4 stock split on April 13, 2005 which was paid in the form of a 25% stock dividend on June 8, 2005 to shareholders of record as of May 17, 2005. The historical annual and quarterly share and per-share information included in this Current Report on Form 8-K has been restated for the effect of this stock split.

ITEM 9.01 FINANCIAL STATEMENTS AND EXHIBITS


Exhibit
No.		Description

23.1		Consent of Independent Registered Public Accounting Firm
99.1		Item 6 — Selected Financial Data (December 31, 2004)
99.2		Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of
		Operations (December 31, 2004)
99.3		Item 8 — Financial Statements and Supplementary Data (December 31, 2004)
99.4		Item 1 — Financial Statements (Unaudited — March 31, 2005)
99.5		Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of
		Operations (March 31, 2005)
99.6		Item 1 — Financial Statements (Unaudited — June 30, 2005)
99.7		Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of
		Operations (June 30, 2005)

SIGNATURE

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 hereunto duly authorized.

FULTON FINANCIAL CORPORATION



Date: December 5, 2005	/s/ Charles J. Nugent
	Charles J. Nugent
	Senior Executive Vice President and Chief Financial Officer

EX-23.1 2 w15301exv23w1.txt CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM EXHIBIT 23.1 Consent of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Fulton Financial Corporation: We consent to the incorporation by reference in the registration statements (No. 333-05481, No. 333-44788, No. 333-81377, No. 333-64744, No. 333-76600, No. 333-76596, No. 333-76594, No. 333-107625, No. 333-114206, No. 333-116625, No. 333-121896, and No. 333-126281) on Forms S-8 and on registration statements (No. 33-37835, No. 333-61268, and No. 333-123532) on Forms S-3 of Fulton Financial Corporation of our reports dated February 22, 2005, except as described in note M, which is as of November 9, 2005, with respect to the consolidated balance sheets of Fulton Financial Corporation as of December 31, 2004 and 2003, and the related consolidated statements of income, shareholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2004, management's assessment of the effectiveness of internal control over financial reporting as of December 31, 2004 and the effectiveness of internal control over financial reporting as of December 31, 2004, which reports appear in the December 31, 2004 annual report on Form 10-K of Fulton Financial Corporation. Our report dated February 22, 2005, on management's assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting as of December 31, 2004, contains an explanatory paragraph that states Fulton Financial Corporation acquired First Washington FinancialCorp. on December 31, 2004, and management excluded from its assessment of the effectiveness of Fulton Financial Corporation's internal control over financial reporting as of December 31, 2004, First Washington FinancialCorp.'s internal control over financial reporting associated with total assets of approximately $585 million and total revenues of $0 included in the consolidated financial statements of Fulton Financial Corporation as of and for the year ended December 31, 2004. Our audit of internal control over financial reporting of Fulton Financial Corporation also excluded an evaluation of the internal control over financial reporting fo First Washington FinancialCorp. /s/ KPMG LLP Harrisburg, Pennsylvania November 30, 2005 4 EX-99.1 3 w15301exv99w1.txt ITEM 6 - SELECTED FINANCIAL DATA (DECEMBER 31, 2004) . . . EXHIBIT 99.1 ITEM 6. SELECTED FINANCIAL DATA (DECEMBER 31, 2004) 5-YEAR CONSOLIDATED SUMMARY OF FINANCIAL RESULTS (DOLLARS IN THOUSANDS, EXCEPT RATIOS AND PER-SHARE DATA)

- ---------- (1) Adjusted for stock dividends and stock splits. (2) Net income divided by average shareholders' equity, net of goodwill and intangible assets. 5 EX-99.2 4 w15301exv99w2.txt ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DECEMBER 31, 2004) EXHIBIT 99.2 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DECEMBER 31, 2004) Management's Discussion and Analysis of Financial Condition and Results of Operations (Management's Discussion) concerns Fulton Financial Corporation (the Corporation), a financial holding company registered under the Bank Holding Company Act and incorporated under the laws of the Commonwealth of Pennsylvania in 1982, and its wholly-owned subsidiaries. This discussion and analysis should be read in conjunction with the consolidated financial statements and other financial information presented in this report. FORWARD-LOOKING STATEMENTS The Corporation has made, and may continue to make, certain forward-looking statements with respect to acquisition and growth strategies, market risk, the effect of competition on net interest margin and net interest income, investment strategy and income growth, investment securities gains, other than temporary impairment of investment securities, deposit and loan growth, asset quality, balances of risk-sensitive assets to risk-sensitive liabilities, employee benefits and other expenses, amortization of goodwill and intangible assets, capital and liquidity strategies and other financial and business matters for future periods. The Corporation cautions that these forward-looking statements are subject to various assumptions, risks and uncertainties. Because of the possibility that the underlying assumptions may change, actual results could differ materially from these forward-looking statements. In addition to the factors identified herein, the following could cause actual results to differ materially from such forward-looking statements: pricing pressures on loan and deposit products, actions of bank and non-bank competitors, changes in local and national economic conditions, changes in regulatory requirements, actions of the Federal Reserve Board (FRB), creditworthiness of current borrowers, customers' acceptance of the Corporation's products and services and acquisition pricing and the ability of the Corporation to continue making acquisitions. The Corporation's forward-looking statements are relevant only as of the date on which such statements are made. By making any forward-looking statements, the Corporation assumes no duty to update them to reflect new, changing or unanticipated events or circumstances. OVERVIEW As a financial institution with a focus on traditional banking activities, the Corporation generates the majority of its revenue through net interest income, the difference between interest income earned on loans and investments and interest paid on deposits and borrowings. Growth in net interest income is dependent upon balance sheet growth and maintaining or increasing the net interest margin, which is net interest income as a percentage of average interest-earning assets. The Corporation also generates revenue through fees earned on the various services and products offered to its customers and through sales of assets, such as loans or investments. Offsetting these revenue sources are provisions for credit losses on loans, administrative expenses and income taxes. The Corporation's net income for 2004 increased $13.2 million, or 9.7%, from $136.4 million in 2003 to $149.6 million in 2004. Diluted net income per share increased $0.03, or 3.1%, from $0.96 per share in 2003 to $0.99 per share in 2004. In 2004, the Corporation realized a return on average assets of 1.45% and a return on average tangible equity of 18.58% compared to 1.55% and 17.33% in 2003. Net income for 2003 increased $5.4 million, or 4.1%, from $131.0 million in 2002 to $136.4 million in 2003. Diluted net income per share increased $0.04, or 4.3%, from $0.92 per share in 2002 to $0.96 per share in 2003. The Corporation adopted Statement of Financial Accounting Standards No. 123R, "Share-Based Payment" (Statement 123R) in the quarter ended September 30, 2005. Statement 123R requires that the fair value of equity awards to employees be recognized as compensation expense over the period during which an employee is required to provide service in exchange for such award. The Corporation adopted Statement 123R using "modified retrospective application" and, therefore, all financial information in this report has been restated to reflect the impact of adoption. See Note M, "Stock-Based Compensation Plans and Shareholders' Equity" in the Notes to Consolidated Financial Statements for information on the impact of adopting Statement 123R and its effect on prior periods. The increase in earnings in 2004 was driven by a $53.2 million, or 17.5%, increase in net interest income due to both internal and external growth and a stable net interest margin. Contributing to this increase was a $6.6 million, or 5.8%, increase in other income (excluding securities gains), primarily as a result of acquisitions, and a $5.0 million, or 51.4%, reduction in the provision for loan 6 losses due to continued strong asset quality. These items were offset by a $43.9 million, or 18.8%, increase in other expenses, as a result of both internal and external growth, and a $2.1 million, or 10.8%, reduction in investment securities gains. The following summarizes some of the more significant factors that influenced the Corporation's 2004 results. Acquisitions - In August 2003, the Corporation acquired Premier Bancorp, Inc. (Premier), a $600 million bank holding company located in Doylestown, Pennsylvania whose primary subsidiary was Premier Bank, strengthening its presence in eastern Pennsylvania markets. In December 2003, the Corporation acquired approximately $165 million of agricultural loans in Central Pennsylvania and Delaware. In April 2004, the Corporation acquired Resource Bankshares Corporation, (Resource), an $885 million financial holding company located in Virginia Beach, Virginia whose primary subsidiary was Resource Bank. This was the Corporation's first acquisition in Virginia, allowing it to enter a new geographic market. Results for 2004 in comparison to 2003 were impacted by these acquisitions (referred to collectively as the "Acquisitions"). On December 31, 2004, the Corporation acquired First Washington FinancialCorp (First Washington), of Windsor, New Jersey. First Washington was a $490 million bank holding company whose primary subsidiary was First Washington State Bank, which operates sixteen community banking offices in Mercer, Monmouth, and Ocean Counties in New Jersey. The accounts of First Washington are included in the Corporation's December 31, 2004 consolidated balance sheet, however, First Washington did not impact average balances or the consolidated statement of income. On January 11, 2005, the Corporation entered into a merger agreement to acquire SVB Financial Services, Inc. (SVB) of Somerville, New Jersey. SVB is a $475 million bank holding company whose primary subsidiary is Somerset Valley Bank, which operates eleven community banking offices in Somerset, Hunterdon and Middlesex counties in New Jersey. The acquisition is expected to be completed in the third quarter of 2005. For additional information on the terms of this pending acquisition, see Note Q, "Mergers and Acquisitions", in the Notes to Consolidated Financial Statements. Acquisitions have long been a supplement to the Corporation's internal growth. These recent and pending acquisitions provide the opportunity for additional growth as they will allow the Corporation's existing products and services to be sold in new markets. The Corporation's acquisition strategy focuses on high growth areas with strong market demographics and targets organizations that have a comparable corporate culture, strong performance and good asset quality, among other factors. Under its "supercommunity" banking philosophy, acquired organizations generally retain their status as separate legal entities, unless consolidation with an existing affiliate bank is practical. Back office functions are generally consolidated to maximize efficiencies. Merger and acquisition activity in the financial services industry has been very competitive in recent years, as evidenced by the prices paid for certain acquisitions. While the Corporation has been an active acquirer, management is committed to basing its pricing on rational economic models. Management will continue to focus on generating growth in the most cost-effective manner. Asset Quality - Asset quality refers to the underlying credit characteristics of borrowers and the likelihood that defaults on contractual loan payments will result in charge-offs of account balances. Asset quality is generally a function of economic conditions, but can be managed through conservative underwriting and sound collection policies and procedures. The Corporation has been able to maintain strong asset quality through different economic cycles, attributable to its credit culture and underwriting policies. This trend continued in 2004 as asset quality measures such as non-performing assets to total assets and net charge-offs to average loans improved in comparison to 2003, allowing a reduction in the provision for loan losses. While overall asset quality has remained strong, deterioration in quality of one or several significant accounts could have a detrimental impact and result in losses that may not be foreseeable based on current information. In addition, rising interest rates could increase the total payments of borrowers and could have a negative impact on their ability to pay according to the terms of their loans. Interest Rates - During the second half of 2004, the FRB increased short-term interest rates a total of 1.25%, with the overnight borrowing, or Federal funds, rate ending the year at 2.25%. The average Federal funds rate for the year increased 22 basis points from 1.13% in 2003 to 1.35% in 2004 and the average prime lending rate increased from 4.13% in 2003 to 4.35% in 2004. This increase in rates resulted in an expansion of the Corporation's net interest margin during 2004 after decreasing significantly during 2003. While the net interest margin for the year increased only slightly, the improvement is evident in the quarterly trend, which is shown in the following table: 7

Unlike short-term interest rates, longer-terms rates remained relatively flat, with ten-year United States Treasury rates beginning and ending the year at about the same level. However, this level was higher than the historic lows experienced during 2002 and 2003 and, consequently, mortgage refinance activity continued its relative slowdown which started during the third and fourth quarter of 2003. Long-term interest rate levels also continued to affect the Corporation's deposit mix as funds from maturing time deposits continued to flow into core demand and savings accounts as customers were reluctant to lock into the relatively low rates being offered on time deposit products. In a rising rate environment, the Corporation expects improvements in net interest income, as discussed in the "Market Risk" section of Management's Discussion. Increasing long-term rates, however, tend to have a detrimental impact on mortgage loan origination volumes and related mortgage-banking income. Regulatory Environment - The Corporation is a registered financial holding company and its subsidiary banks are depository institutions whose deposits are insured by the Federal Deposit Insurance Corporation (FDIC). The Corporation and its subsidiaries are subject to various regulations and examinations by bank regulatory authorities, including the Federal Reserve, the FDIC, the Office of the Comptroller of the Currency and certain state agencies. The financial services industry has been subjected to heightened scrutiny by bank regulatory authorities in the areas of Bank Secrecy Act compliance and other anti-money laundering rules and regulations. As a result the Corporation has hired additional staff for compliance related activities. As a publicly traded company, the Corporation is also subject to Securities and Exchange Commission (SEC) regulations, which govern the frequency and content of financial information required to be made available to the public. Recent legislative and regulatory actions of the Federal government have significantly changed financial reporting requirements, primarily as a result of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley). For the 2004 financial statements and footnotes, Sarbanes-Oxley required management to issue a report on the effectiveness of its internal controls over financial reporting. In addition, the Corporation's independent public accountants were required to issue an opinion on management's report and the Corporation's internal controls over financial reporting. These reports can be found after the Consolidated Financial Statements and Notes to Consolidated Financial Statements. The burden of compliance with the new reporting requirements has been significant for all publicly traded companies, including the Corporation. The cost includes both the time devoted by its employees to complete the documentation and testing of controls and the expense for engaging professionals to assist in the process. In addition, the Corporation experienced a significant increase in independent accountant fees related to the internal controls testing process. See additional information in the "Other Expenses" section of Management's Discussion. 8 RESULTS OF OPERATIONS NET INTEREST INCOME Net interest income is the most significant component of the Corporation's net income, accounting for approximately 75% of total 2004 revenues, excluding investment securities gains. The ability to manage net interest income over a variety of interest rate and economic environments is important to the success of a financial institution. Growth in net interest income is generally dependent upon balance sheet growth and maintaining or growing the net interest margin. The "Market Risk" section of Management's Discussion beginning on page 25 provides additional information on the policies and procedures used by the Corporation to manage net interest income. The following table summarizes the average balances and interest earned or paid on the Corporation's interest-earning assets and interest-bearing liabilities.

- ---------- (1) Includes non-performing loans. (2) Balances include amortized historical cost for available for sale securities. The related unrealized holding gains (losses) are included in other assets. (3) Based on marginal Federal income tax rate and statutory interest expense disallowances. 9 The following table sets forth a summary of changes in interest income and interest expense resulting from changes in volumes (average balances) and changes in rates:

- ---------- Note: Changes which are partly attributable to rate and volume are allocated based on the proportion of the direct changes attributable to rate and volume. 2004 vs. 2003 Net interest income increased $53.2 million, or 17.5%, from $304.4 million in 2003 to $357.6 million in 2004, primarily as a result of earning asset growth as the Corporation's net interest margin for the year was relatively constant at 3.83% for 2004 compared to 3.82% for 2003. Average earning assets grew 16.5%, from $8.2 billion in 2003 to $9.6 billion in 2004. The Acquisitions contributed approximately $900 million to this increase in average balances. Interest income increased $58.1 million, or 13.3%, mainly as a result of the 16.5% increase in average earning assets, which resulted in a $79.1 million increase in interest income. This increase was partially offset by the $21.0 million decrease in interest income that resulted from the decline in the average yield earned. This reflects the impact of customers favoring floating rate loans which tend to carry lower interest rates than fixed rate products. 10 The increase in average interest-earning assets was due to loan growth, both internal and through acquisitions, as investment balances remained relatively flat. Average loans increased by $1.3 billion, or 23.5%, to $6.9 billion in 2004. The following table presents the growth in average loans, by type:

The Acquisitions contributed approximately $675.6 million to this increase in average balances. The following table presents the average balance impact of the Acquisitions, by type:

The following table presents the growth in average loans, by type, excluding the average balances contributed by the Acquisitions:

11 Loan growth continued to be strong in the commercial and commercial mortgage categories. The growth shown in the commercial - agricultural category reflects the agricultural loan portfolio purchased in December 2003. The reduction in mortgage loan balances was due to customer refinance activity that occurred during 2003. The Corporation generally sells newly originated fixed rate mortgages in the secondary market to promote liquidity and manage interest rate risk. Home equity loans increased significantly due to promotional efforts and customers using home equity loans as a cost-effective refinance alternative and as a preferred type of consumer loan. Consumer loans decreased, reflecting customers' repayment of these loans with tax-advantaged residential mortgage or home equity loans. In addition, the indirect finance market remains extremely competitive with the participation of vehicle manufacturers. The average yield on loans during 2004 was 5.75%, a 36 basis point, or 5.9%, decline from 2003. Much of the recent loan growth has been experienced in the floating rate categories that tend to carry lower interest rates than fixed-rate products. Average investments decreased slightly during 2004, however, without the impact of the Acquisitions, the investment balances would have decreased $165.9 million, or 6.6%. The Corporation's investment balances had increased over the last few years due to both significant deposit growth and the use of limited strategies to manage the Corporation's gap position and to take advantage of low short-term borrowing rates. During 2004, the Corporation did not reinvest a significant portion of investment maturities in order to minimize interest rate risk in expectation of a rising rate environment and to help fund loan growth. The average yield on investment securities declined slightly from 3.58% in 2003 to 3.53% in 2004. Premium amortization, which is accounted for as a reduction of interest income, was $20.0 million in 2003 compared to $10.5 million in 2004. The benefit from the lower premium amortization was offset by the reduction in stated yields experienced throughout 2004. Interest expense increased $4.9 million, or 3.7%, to $136.0 million in 2004 from $131.1 million in 2003, mainly as a result of $1.2 billion increase in average interest-bearing liabilities, which included approximately $800 million added by the Acquisitions. The increase in average interest-bearing liabilities resulted in an increase in interest expense of $17.5 million during 2004. This increase was partially offset by a $12.6 million decrease due to the 23 basis point decrease in the cost of total interest-bearing liabilities. The cost of interest-bearing deposits declined 25 basis points, or 14.1%, from 1.77% in 2003 to 1.52% in 2004. This reduction was due to both the impact of declining short-term interest rates in the first half of 2003 and the continuing shift in the composition of deposits from higher-rate time deposits to lower-rate demand and savings deposits. Customers continued to exhibit an unwillingness to invest in certificates of deposit at the rates available, instead keeping their funds in demand and savings products. The following table presents the growth in average deposits, by type:

12 The Acquisitions accounted for approximately $595.4 million of the increase in average balances. The following table presents the average balance impact of the Acquisitions, by type:

The following table presents the growth in average deposits, by type, excluding the contribution of the Acquisitions:

Average borrowings increased significantly during 2004, with average short-term borrowings increasing $499.5 million, or 67.6%, to $1.2 billion, and average long-term debt increasing $71.2 million, or 12.6%, to $637.7 million. The Acquisitions added $174.6 million to the short-term borrowings increase and $83.6 million to the long-term debt increase. The additional increase in short-term borrowings resulted primarily from certain limited strategies employed during 2003 to manage the Corporation's gap position and to take advantage of low short-term borrowing rates. In addition, customer cash management accounts, which are included in short-term borrowings, grew $54.9 million, or 15.6%, to an average of $406.2 million in 2004. 2003 vs. 2002 Net interest income decreased $6.6 million, or 2.1%, from $311.1 million in 2002 to $304.4 million in 2003. While average earning assets grew 11.5%, from $7.4 billion in 2002 to $8.2 billion in 2003, the net interest margin declined 12.2%, or 53 basis points, from 4.35% in 2002 to 3.82% in 2003 as a result of the interest rate environment. During 2003, yields earned on assets decreased further than rates paid on liabilities. Interest income decreased $33.8 million, or 7.2%, mainly as a result of the 107 basis point decrease in the average yield on earning assets. Average yields decreased during 2003 due both to the general decrease in short-term interest rates as well as the shift in earning assets, on a percentage basis, from higher yielding loans to generally lower yielding investment securities. The decrease of $80.5 million as a result of rates was partially offset by a $46.7 million increase due to average earning asset growth. Average loans increased $207.7 million, or 3.9%, to $5.6 billion in 2003. Loan growth was particularly strong in the commercial and commercial mortgage categories. Even factoring out the loans acquired in the Premier acquisition, these categories both grew approximately 8.0%. The significant reduction in mortgage loan balances was due to customer refinance activity that continued at a high rate through much of the year. The Corporation generally sells newly originated fixed rate mortgages in the secondary market to promote liquidity and manage interest rate risk. Home equity loans increased significantly due to promotional efforts and customers using home equity loans as a cost-effective refinance alternative. Consumer loans decreased, reflecting customers' repayment of these loans with tax-advantaged residential mortgage or home equity loans. In addition, many vehicle manufacturers continued to offer attractive financing rates, with which the Corporation chose not to compete. 13 The average yield on loans during 2003 was 6.11%, a 77 basis point, or 11.2%, decline from 2002. This reflects the 55 basis point reduction in the Corporation's average prime lending rate from 4.68% in 2002 to 4.13% in 2003, as well as higher than normal prepayments received on fixed rate commercial and commercial mortgage loans. Average investment securities increased $618.5 million, or 31.7%, during 2003. The increase was attributable primarily to deposit growth exceeding loan growth. Total average deposit growth of $452.7 million exceeded average loan growth by $245.0 million during 2003. In addition, the Corporation employed certain limited strategies to manage the Corporation's gap position and to take advantage of low short-term borrowing rates. Most of the growth in investment securities was in mortgage-backed securities, which increased by $553.2 million, or 38.1%. The average yield on investment securities declined significantly from 5.03% in 2002 to 3.58% in 2003. This 28.8% decrease was due to both the relatively short maturity of the portfolio as well as the high prepayment levels experienced on mortgage-backed securities. During 2003 and 2002, most mortgage-backed securities were being purchased at premiums. As longer-term interest rates continued to fall through the first half of 2003, the prepayments on these securities exceeded expected levels. Prepayments negatively impact yields through the acceleration of premium amortization expense, which is accounted for as a reduction of interest income. Premium amortization was $20.0 million in 2003 compared to $5.7 million in 2002. Approximately $17.3 million of premium amortization during 2003 was accelerated amortization. Interest expense decreased $27.1 million, or 17.1%, to $131.1 million in 2003 from $158.2 million in 2002, mainly as a result of the 69 basis point decrease in the cost of total interest-bearing liabilities. This decrease in cost resulted in a $36.7 million decrease in interest expense, which was partially offset by a $9.6 million increase in interest expense due to average balance growth. The cost of interest-bearing deposits declined 73 basis points, or 29.2%, from 2.50% in 2002 to 1.77% in 2003. This reduction was due to both the impact of declining short-term interest rates and the continuing shift in the composition of deposits from higher-rate time deposits to lower-rate demand and savings deposits. Customers continued to exhibit an unwillingness to invest in certificates of deposit at the rates available, instead keeping their funds in demand and savings products. The acquisition of Premier added $187.4 million to the total average balance of deposits in 2003. If those balances were factored out, the deposit categories would show the following increases (decreases) - noninterest-bearing demand, 12.9%, interest-bearing demand, 21.6%, savings/money market, 6.7%, and time deposits, (6.5)%. Average short-term borrowings increased $304.1 million, or 70.0%, to $738.5 million in 2003, while average long-term debt increased $90.0 million, or 18.9%, to $566.4 million in 2003. The increase in short-term borrowings resulted primarily from certain limited strategies to manage the Corporation's gap position and to take advantage of low short-term borrowing rates. In addition, customer cash management accounts, which are included in short-term borrowings, grew $53.8 million, or 18.1%, to reach $351.3 million in 2003. PROVISION AND ALLOWANCE FOR LOAN LOSSES The Corporation accounts for the credit risk associated with lending activities through its allowance and provision for loan losses. The provision is the expense recognized in the income statement to adjust the allowance to its proper balance, as determined through the application of the Corporation's allowance methodology procedures. These procedures include the evaluation of the risk characteristics of the portfolio and documentation in accordance with the Securities and Exchange Commission's (SEC) Staff Accounting Bulletin No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues" (SAB 102). See "Critical Accounting Policies" on page 23 for a discussion of the Corporation's allowance for loan loss evaluation methodology. 14 A summary of the Corporation's loan loss experience follows:

- ---------- (1) Includes accruing loans past due 90 days or more. 15 The following table presents the aggregate amount of non-accrual and past due loans and other real estate owned (3):

- ---------- (1) As of December 31, 2004, the additional interest income that would have been recorded during 2004 if nonaccrual loans had been current in accordance with their original terms was approximately $1.5 million. The amount of interest income on nonaccrual loans that was included in 2004 income was approximately $2.8 million. (2) Accrual of interest is generally discontinued when a loan becomes 90 days past due as to principal and interest. When interest accruals are discontinued, interest credited to income is reversed. Nonaccrual loans are restored to accrual status when all delinquent principal and interest becomes current or the loan is considered secured and in the process of collection. Certain loans, primarily residential mortgages, that are determined to be sufficiently collateralized may continue to accrue interest after reaching 90 days past due. (3) Excluded from the amounts presented at December 31, 2004 are $124.0 million in loans where possible credit problems of borrowers have caused management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms. These loans are considered to be impaired under Statement 114, but continue to pay according to their contractual terms and are therefore not included in non-performing loans. Nonaccrual loans include $6.6 million of impaired loans. The following table summarizes the allocation of the allowance for loan losses by loan type:

Over the past several years, the procedures used by the banking industry to evaluate the allowance for loan losses have received increased attention from the SEC, regulatory bodies and the accounting industry. These groups have attempted to reconcile the accounting theory of reserving for loan losses, which requires that the allowance represent management's estimate of the losses inherent in the loan portfolio as of the balance sheet date, with the regulatory goals of safety and soundness. While the resulting guidance provided by these groups has not changed the accounting, it has focused on clarifying the application of existing accounting pronouncements and improving documentation. As with others in the industry, the Corporation has used this guidance to improve its process and its documentation. The unallocated allowance for loan losses, as shown in the preceding table, decreased from 16% at December 31, 2003 to 12% at December 31, 2004. The Corporation continues to monitor its allowance methodology to ensure compliance with both regulatory and accounting industry policies. 16 The provision for loan losses decreased $5.0 million from $9.7 million in 2003 to $4.7 million in 2004, after decreasing $2.2 million in 2003. These decreases reflect the continued improvement in the Corporation's asset quality reflected in both lower net charge-offs and lower non-performing assets ratios. Net charge-offs as a percentage of average loans were 0.06% in 2004, an eleven basis point improvement over 0.17% in 2003, which was a five basis point decrease from 2002. Non-performing assets as a percentage of total assets decreased slightly from 0.33% at December 31, 2003 to 0.30% at December 31, 2004, after decreasing 14 basis points in 2003. The declines in both ratios reflect the improving quality of the Corporation's portfolio during the years. The provision for loan losses in 2004 resulted from the Corporation's allowance allocation procedures. The continued growth of the Corporation's commercial loan and commercial mortgage portfolios, which are inherently more risky than other loan types, is a trend which would indicate the need for a higher allowance balance. Offsetting these trends were the improvements in the quality of the Corporation's portfolio, as evidenced by its improving asset quality measures over the past several years. The net result of the Corporation's allowance allocation procedures was a provision for loan losses that was $5.0 million less than 2003 and was comparable to total net charge-offs for the year. Management believes that the allowance balance of $89.6 million at December 31, 2004 is sufficient to cover losses inherent in the loan portfolio on that date and is appropriate based on applicable accounting standards. OTHER INCOME The following table presents the components of other income for each of the past three years:

Total other income increased $4.5 million, or 3.3%, from $134.4 million in 2003 to $138.9 million in 2004, after increasing $20.4 million, or 17.9%, from $114.0 million in 2002. Excluding investment securities gains, other income increased $6.6 million, or 5.8%, in 2004 and $9.5 million, or 9.0%, in 2003. While the acquisition of Premier did not have a significant impact on other income growth during 2003 and 2004, the acquisition of Resource Bank contributed $14.4 million to total other income in 2004. Investment management and trust services income grew $919,000, or 2.7%, in 2004 and $4.8 million, or 16.4%, in 2003. Trust commission income was relatively flat in 2004 after increasing $1.5 million, or 8.3%, in 2003 as improvements in the equity markets increased values of assets under management. Brokerage revenue increased $974,000, or 8.3%, in 2004 and $3.0 million, or 33.8%, in 2003 as a result of the performance of the equity markets and increased annuity sales. Total service charges on deposit accounts increased $951,000, or 2.5%, in 2004 and $1.0 million, or 2.7%, in 2003. Overdraft fees increased $1.2 million, or 7.5%, in 2004 (including $175,000 due to the Acquisitions) and $407,000, or 2.7%, in 2003 (including $46,000 due to the Acquisitions). Cash management fees increased $50,000, or 0.7%, in 2004 and $260,000, or 3.6%, in 2003. The low interest rate environment has made cash management services less attractive for smaller business customers. Other service charges and fees increased $1.6 million, or 8.7%, in 2004 (including $280,000 due to the Acquisitions) and $1.1 million, or 6.3%, in 2003 (including $53,000 due to the Acquisitions). The increase in both years was driven by growth in letter of credit fees, merchant fees and debit card fees. Letter of credit fees increased $245,000, or 7.2% in 2004 and $889,000, or 35.1%, in 2003, and merchant fees increased $372,000, or 8.2%, in 2004 and $491,000, or 12.2%, in 2003, all as a result of an increased focus on growing these business lines. Debit card fees increased $549,000, or 10.7%, in 2004 (including $55,000 due to the Acquisitions) and $122,000, or 2.4%, in 2003 (including $19,000 due to the Acquisitions). While the earnings rate on debit card transactions has decreased, the Corporation has seen an increase in transaction volume. 17 Gains on sales of mortgage loans increased $297,000, or 1.6%, in 2004 after increasing $5.0 million, or 36.0%, in 2003 and $4.4 million, or 45.6% in 2002. Resource Bank contributed $11.1 million to the 2004 amount and without that amount, this category would show a $10.8 million, or 57.0%, decrease. The decrease in the current year was expected based on the increase in interest rates from their historic lows and the resulting reduction in the level of mortgage refinancing activity. Investment securities gains decreased $2.1 million, or 10.8%, in 2004 after increasing $10.9 million, or 120.8%, in 2003. Investment securities gains included realized gains on the sale of equity securities of $14.8 million and $17.3 million in 2004 and 2003, respectively, reflecting the general improvement in the equity markets and bank stocks in particular, and $3.1 million and $5.9 million in 2004 and 2003, respectively, on the sale of debt securities, which were generally sold to take advantage of the interest rate environment. These gains were offset by write-downs of $137,000 in 2004 and $3.3 million in 2003 for specific equity securities deemed to exhibit other than temporary impairment in value. As of December 31, 2004, the impaired securities still being held in the portfolio had recovered approximately $1.4 million of the original write-down amount. Other income increased $2.8 million, or 66.0%, in 2004 after decreasing $2.4 million, or 36.1%, in 2003. The increase in 2004 is entirely due to the acquisition of Resource Bank, which generated significant fee income from its mortgage-related business. The decrease in 2003 resulted from the reversal of $848,000 of negative goodwill in 2002 and a decrease in mortgage loan servicing income as the amortization of mortgage servicing rights increased. OTHER EXPENSES The following table presents the components of other expenses for each of the past three years:

Total other expenses increased $43.9 million, or 18.8%, in 2004 (including $30.0 million due to the Acquisitions) and $7.6 million, or 3.4% in 2003 (including $4.8 million due to the Acquisitions). 18 The following table presents the amounts included in the above totals which were contributed by the Acquisitions:

The following table presents the components of other expenses for each of the past three years, excluding the amounts contributed by the Acquisitions:

The discussion that follows addresses changes in other expenses, excluding the Acquisitions. Salaries and employee benefits increased $11.5 million, or 8.5%, in 2004 and $6.1 million, or 4.7%, in 2003. The salary expense component increased $6.4 million, or 5.7%, in 2004 and $4.4 million, or 4.1%, in 2003, driven by salary increases for existing employees, as total average full-time equivalent employees remained relatively consistent at approximately 2,900. In 2004, stock-based compensation expense increased $1.8 million, or 86.4%, as the Corporation granted more stock options to employees. See Note M, "Stock-Based Compensation Plans and Shareholders' Equity" in the Notes to Consolidated Financial Statements. In 2003, an increase in commission expense related to brokerage business also contributed to the increase in salary expense. Employee benefits increased $5.1 million, or 21.7%, in 2004 and $1.7 million, or 7.9%, in 2003 driven mainly by continued increases in healthcare costs and retirement plan expenses. See additional discussion of the Corporations defined benefit pension plan in Note L, "Employee Benefit Plans", in the Notes to Consolidated Financial Statements. Net occupancy expense increased $1.4 million, or 7.0%, to $20.9 million in 2004 after increasing $1.8 million, or 10.2%, in 2003. The increases resulted from the expansion of the branch network and the addition of new office space for existing affiliates. Equipment expense decreased $1.0 million, or 9.9%, in 2004 after decreasing $928,000, or 8.2%, in 2003. The decrease in both years was due to lower depreciation expense as certain equipment became fully depreciated. Data processing expense decreased $651,000, or 5.8%, in 2004 after decreasing $823,000, or 6.9%, in 2003. The Corporation has been successful over the past few years in renegotiating key processing contracts with certain vendors. Advertising expense decreased $76,000, or 1.3%, in 2004 after decreasing $534,000, or 8.2%, in 2003. The Corporation had made a conscious decision to control advertising spending in both 2004 and 2003. Intangible amortization increased $1.7 million, or 116.4%, in 2004 after decreasing $349,000, or 19.0%, in 2003. Intangible amortization consists of the amortization of unidentifiable intangible assets related to branch and loan acquisitions, core deposit intangible assets, and other identified intangible assets. The increase in 2004 primarily represents the amortization of intangible assets 19 related to the acquisition of an agriculture loan portfolio in December 2003. The decrease in 2003 resulted from an accelerated amortization schedule in connection with a prior branch acquisition. Other expense increased $916,000, or 2.1%, in 2004 after decreasing $2.5 million, or 5.4%, in 2003. The Corporation's costs increased as a result of complying with the provisions of the Sarbanes-Oxley Act of 2002. These costs were realized in external audit fees, which increased from $363,000 in 2003 to $1.6 million in 2004 as well as an additional $400,000 in consulting expense during 2004. These cost increases were offset by reductions in operating risk loss, other real estate expenses and legal fees. In 2003, many categories of costs decreased including operating risk loss, legal fees and non-income taxes. Additionally, there were amounts accrued for leasing residual value losses and severance in 2002 that did not recur in 2003. INCOME TAXES Income taxes increased $5.6 million, or 9.5%, in 2004 and $2.9 million, or 5.2%, in 2003. The Corporation's effective tax rate (income taxes divided by income before income taxes) remained fairly stable at 30.2%, 30.2% and 30.0% in 2004, 2003 and 2002, respectively. In general, the variances from the 35% Federal statutory rate consisted of tax-exempt interest income and investments in low and moderate income housing partnerships, which generate Federal tax credits. Net credits were $4.5 million, $4.0 million and $4.0 million in 2004, 2003 and 2002, respectively. For additional information regarding income taxes, see Note K, "Income Taxes" in the Notes to Consolidated Financial Statements. 20 FINANCIAL CONDITION Total assets increased $1.4 billion, or 14.2%, to $11.2 billion at December 31, 2004. Excluding the Resource and First Washington acquisitions (the 2004 Acquisitions), total assets decreased $235.9 million, or 2.4%. During 2004, maturing investment securities were not reinvested, instead paying off short-term borrowings and funding loan growth, in expectation of continued increases in short-term interest rates. Total loans increased $1.4 billion, or 23.2% ($552.0 million, or 9.1%, excluding the 2004 Acquisitions), while total investments decreased $477.3 million, or 16.3% ($808.8 million, or 27.6%, excluding the 2004 Acquisitions). Total deposits increased $1.1 billion, or 16.9%, to $7.9 billion at December 31, 2004, with $1.0 billion of the increase attributable to the 2004 Acquisitions. The table below presents a condensed ending balance sheet for the Corporation, adjusted for the balances recorded for the 2004 Acquisitions, in comparison to 2003 ending balances.

- ---------- (1) Balances recorded on acquisition dates. (2) Excluding Resource and First Washington. (3) Fulton Financial Corporation, excluding Resource and First Washington as compared to the prior year. 21 LOANS The following table sets forth the amount of loans outstanding as of the dates shown:

Total loans, net of unearned increased $1.4 billion, or 23.1%, in 2004 ($552.5 million, or 9.0%, excluding the 2004 Acquisitions). The internal growth of $552.5 million included increases in total commercial loans ($148.5 million, or 7.6%), commercial mortgage loans ($183.8 million, or 8.1%), construction loans ($42.7 million, or 13.9%), residential mortgages ($22.6 million, or 5.2%), and home equity loans ($168.3 million, or 18.9%), offset partially by decreases in consumer loans ($16.6 million, or 3.2%) and leasing and other loans ($8.0 million, or 10.3%). In 2003, total loans increased $842.9 million, or 15.9% ($319.1 million, or 6.0%, excluding the Premier and purchased loan acquisitions). Excluding these acquisitions, increases in total commercial loans ($45.6 million, or 2.7%), commercial mortgage loans ($177.2 million, or 11.6%), construction loans ($50.6 million, or 20.4%) and residential mortgages ($76.2 million, or 6.1%), were offset by decreases in consumer loans ($27.1 million, or 5.0%) and leasing and other ($3.4 million, or 4.6%). INVESTMENT SECURITIES The following table sets forth the carrying amount of investment securities held to maturity (HTM) and available for sale (AFS) as of the dates shown:

Total investment securities decreased $477.3 million, or 16.4%, ($808.8 million, or 27.6%, excluding the 2004 Acquisitions), to a balance of $2.4 billion at December 31, 2004. In 2003, investment securities increased $510.9 million, or 21.1%, to reach a balance of $2.9 billion. As noted above, the decrease in 2004 represented maturities and prepayments that were not reinvested due to the expectation of increasing short-term interest rates. 22 The Corporation classified virtually its entire investment portfolio as available for sale at December 31, 2004 and, as such, these investments were recorded at their estimated fair values. As short-term interest rates increased in the second half of 2004, the net unrealized gain on non-equity available for sale investment securities decreased $24.8 million from a net unrealized gain of $3.8 million at December 31, 2003 to a net unrealized loss of $21.1 million at December 31, 2004. At December 31, 2004, equity securities consisted of FHLB and other government agency stock ($63.4 million), stocks of other financial institutions ($69.2 million) and mutual funds and other ($37.4 million). The bank stock portfolio has historically been a source of capital appreciation and realized gains ($14.8 million in 2004, $17.3 million in 2003 and $7.4 million in 2002). Management periodically sells bank stocks when, in its opinion, valuations and market conditions warrant such sales. OTHER ASSETS Cash and due from banks decreased $22.9 million, or 7.6% ($49.2 million, or 16.4%, excluding the 2004 Acquisitions), in 2004, following a $13.9 million, or 4.4%, decrease in 2003. Because of the daily fluctuations that result in the normal course of business, cash is more appropriately analyzed in terms of average balances. On an average balance basis, cash and due from banks increased $36.2 million, or 12.9%, from $280.0 million in 2003 to $316.2 million in 2004, following a $26.5 million, or 10.4%, increase in 2003. The increase in both years resulted from acquisitions and growth in the Corporation's branch network. Premises and equipment increased $26.1 million, or 21.6%, in 2004 to $146.9 million, which included $22.4 as a result of the 2004 Acquisitions. The remaining increase reflects additions of $16.2 million primarily for the construction of various new branch and office facilities, partially offset by current year depreciation expense. Goodwill and intangible assets increased $244.5 million, or 168.9%, in 2004, following a $72.5 million, or 100.3%, increase in 2003, as a result of acquisitions. Other assets increased $50.1 million, or 32.3%, in 2004 to $205.5 million, including $29.8 million as a result of the 2004 Acquisitions, an increase in the net deferred tax asset mainly as a result of decreases in unrealized gains on investment securities, and an $11.9 million increase in investments in low-income housing projects. During 2004, equity investments of $17.5 million were made to eight new partnerships. The Corporation made its initial investment of this type during 1989 and is now involved in 58 partnerships, located in the communities served by its subsidiary banks. The carrying value of these investments was approximately $52.0 million at December 31, 2004. With these investments, the Corporation not only improves the quantity and quality of available housing for low income individuals in support of its banks' Community Reinvestment Act compliance efforts, but also becomes eligible for tax credits under Federal and, in some cases state, programs. DEPOSITS AND BORROWINGS Deposits increased $1.1 billion, or 16.9%, to $7.9 billion at December 31, 2004 ($118.9 million, or 1.8%, excluding the 2004 Acquisitions). This compares to an increase of $506.3 million, or 8.1%, in 2003, ($71.8 million, or 1.1%, excluding the Premier acquisition). The recent trend has been strong growth in core demand and savings accounts, offset by declines in time deposits. Consumers have continued to favor banks over the equity markets, even though market performance has recovered some of its decline from the past few years. In addition, the relatively low interest rate environment resulted in consumers continuing to favor demand and savings products over time deposits. Although short-term rates have increased in 2004, longer-term rate increases have not been as significant. If longer-term rates increase significantly in the future, consumers may shift their deposit funds to higher cost time deposits. During 2004, demand deposits increased $457.1 million, or 17.9% ($234.6 million, or 10.8%, excluding the 2004 Acquisitions), savings deposits increased $165.7 million, or 9.5% ($58.7 million, or 3.8%, excluding the 2004 Acquisitions) and time deposits increased $521,000, or 21.3% (decrease of $174.5 million, or 7.2%, excluding the 2004 Acquisitions). During 2003, demand deposits increased $372.7 million, or 17.1% ($220.8 million, or 10.1%, excluding Premier), savings deposits increased $222.4 million, or 14.5% ($139.0 million, or 9.1%, excluding Premier), while time deposits decreased $88.8 million, or 3.5%, ($287.9 million, or 11.3%, excluding Premier). Many of the trends experienced during 2003 began in 2001 when the FRB started its series of rate cuts. Short-term borrowings, which consist mainly of Federal funds purchased and customer cash management accounts, decreased $202.2 million, or 14.5% ($329.9 million, or 23.6%, excluding the 2004 Acquisitions), in 2004 after increasing $764.5 million, or 120.9%, in 23 2003. The decrease in 2004 was due to strategies to reduce overnight Federal funds purchased in the recent rising rate environment. In 2003, the increase resulted from actions taken to manage the gap position and to take advantage of low short-term borrowing rates. Long-term debt increased $115.5 million, or 20.3% (decrease of $18.5 million, or 3.3%, excluding the 2004 Acquisitions). The decrease in 2004 was due to a decrease in Federal Home Loan Bank advances. Long-term debt increased $33.2 million, or 6.2%, during 2003 mainly due to $25.0 million of junior subordinated debentures assumed from Premier. OTHER LIABILITIES Other liabilities increased $38.6 million, or 37.5% ($19.4 million, or 18.8%, excluding the 2004 Acquisitions), following a $2.1 million, or 2.0%, decrease in 2003. The increase in 2004 was primarily attributable to additional equity commitments for low-income housing projects ($9.2 million increase), an increase in accrued retirement benefits ($2.4 million) and an increase in dividends payable to shareholders ($2.5 million). SHAREHOLDERS' EQUITY Total shareholders' equity of $1.2 billion, or 11.1% of ending total assets, increased $295.8 million, or 31.2%, since December 31, 2003. This growth reflected the issuance of stock to effect the 2004 Acquisitions in the amount of $311.1 million, offset by treasury stock purchases of $79.0 million. Shareholders' equity was also increased by retained earnings of $72.4 million. The Corporation periodically implements stock repurchase plans for various corporate purposes. In addition to evaluating the financial benefits of implementing repurchase plans, management also considers liquidity needs, the current market price per share and regulatory limitations. In 2002, the Board of Directors approved a stock repurchase plan for 7.3 million shares, which was extended through June 30, 2004. During 2004, 1.6 million shares were repurchased under this plan. On June 15, 2004, the Board of Directors approved a stock repurchase plan for 5.0 million shares through December 31, 2004. During 2004, 3.1 million shares were repurchased under this plan, including 1.3 million shares acquired under an accelerated share repurchase program. On December 21, 2004, the Board of Directors extended the stock repurchase plan through June 30, 2005 and increased the total number of shares that could be repurchased to 5.0 million. No shares were purchased under this extended plan in 2004. The Corporation and its subsidiary banks are subject to regulatory capital requirements administered by various banking regulators. Failure to meet minimum capital requirements can initiate certain actions by regulators that could have a material effect on the Corporation's financial statements. The regulations require that banks maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk weighted assets (as defined), and Tier I capital to average assets (as defined). As of December 31, 2004, the Corporation and each of its bank subsidiaries met the minimum capital requirements. In addition, the Corporation and each of its bank subsidiaries' capital ratios exceeded the amounts required to be considered "well-capitalized" as defined in the regulations. See also Note J, "Regulatory Matters", in the Notes to Consolidated Financial Statements. 24 CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS The Corporation has various financial obligations that may require future cash payments. These obligations include the payment of liabilities recorded on the Corporation's balance sheet as well as contractual obligations for purchased services or for operating leases. The following table summarizes significant contractual obligations to third parties, by type, that are fixed and determinable at December 31, 2004:

- ---------- (a) Includes demand deposits and savings accounts, which can be withdrawn by customers at any time. (b) See additional information regarding time deposits in Note H, "Deposits" in the Notes to Consolidated Financial Statements. (c) See additional information regarding borrowings in Note I, "Short-Term Borrowings and Long-Term Debt" in the Notes to Consolidated Financial Statements. (d) See additional information regarding operating leases in Note N, "Leases" in the Notes to Consolidated Financial Statements. (e) Includes significant information technology, telecommunication and data processing outsourcing contracts. Variable obligations, such as those based on transaction volumes, are not included. In addition to the contractual obligations listed in the preceding table, the Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit and interest rate risk that are not recognized in the consolidated balance sheets. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments issued to guarantee the financial or performance obligation of a customer to a third party. Commitments and standby letters of credit do not necessarily represent future cash needs as they may expire without being drawn. The following table presents the Corporation's commitments to extend credit and letters of credit as of December 31, 2004 (in thousands): Commercial mortgage, construction and land development .. $ 689,818 Home equity ............................................. 412,790 Credit card ............................................. 384,504 Commercial and other .................................... 1,851,159 ---------- Total commitments to extend credit ................... $3,338,271 ========== Standby letters of credit ............................... $ 533,094 Commercial letters of credit ............................ 24,312 ---------- Total letters of credit .............................. $ 557,406 ==========

25 CRITICAL ACCOUNTING POLICIES The following is a summary of those accounting policies that the Corporation considers to be most important to the portrayal of its financial condition and results of operations, as they require management's most difficult judgments as a result of the need to make estimates about the effects of matters that are inherently uncertain. Allowance and Provision for Loan Losses - The Corporation accounts for the credit risk associated with its lending activities through the allowance and provision for loan losses. The allowance is an estimate of the losses inherent in the loan portfolio as of the balance sheet date. The provision is the periodic charge to earnings, which is necessary to adjust the allowance to its proper balance. On a quarterly basis, the Corporation assesses the adequacy of its allowance through a methodology that consists of the following: - - Identifying loans for individual review under FASB Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" (Statement 114). In general, these consist of large balance commercial loans and commercial mortgages, that are rated less than "satisfactory" based upon the Corporation's internal credit-rating process. - - Assessing whether the loans identified for review under Statement 114 are "impaired". That is, whether it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. - - For loans identified as impaired, calculating the estimated fair value, using observable market prices, discounted cash flows or the value of the underlying collateral. - - Classifying all non-impaired large balance loans based on credit risk ratings and allocating an allowance for loan losses based on appropriate factors, including recent loss history for similar loans. - - Identifying all smaller balance homogeneous loans for evaluation collectively under the provisions of Statement of Financial Accounting Standards No. 5, "Accounting for Contingencies" (Statement 5). In general, these loans include residential mortgages, consumer loans, installment loans, smaller balance commercial loans and mortgages and lease receivables. - - Statement 5 loans are segmented into groups with similar characteristics and an allowance for loan losses is allocated to each segment based on recent loss history and other relevant information. - - Reviewing the results to determine the appropriate balance of the allowance for loan losses. This review gives additional consideration to factors such as the mix of loans in the portfolio, the balance of the allowance relative to total loans and non-performing assets, trends in the overall risk profile of the portfolio, trends in delinquencies and non-accrual loans and local and national economic conditions. - - An unallocated allowance is maintained to recognize the imprecision in estimating and measuring loss exposure. - - Documenting the results of its review in accordance with SAB 102. The allowance review methodology is based on information known at the time of the review. Changes in factors underlying the assessment could have a material impact on the amount of the allowance that is necessary and the amount of provision to be charged against earnings. Such changes could impact future results. Accounting for Business Combinations - The Corporation accounts for all business acquisitions using the purchase method of accounting as required by Statement of Financial Accounting Standards No. 141, "Business Combinations" (Statement 141). Purchase accounting requires the purchase price to be allocated to the estimated fair values of the assets acquired and liabilities assumed. It also requires assessing the existence of and, if necessary, assigning a value to certain intangible assets. The remaining excess purchase price over the fair value of net assets acquired is recorded as goodwill. The purchase price is established as the value of securities issued for the acquisition, cash consideration paid and certain acquisition-related expenses. The fair values of assets acquired and liabilities assumed are typically established through appraisals, observable market values or discounted cash flows. Management has engaged independent third-party valuation experts to assist in valuing certain assets, particularly intangibles. Other assets and liabilities are generally valued using the Corporation's internal asset/liability modeling system. The assumptions used and the final valuations, whether prepared internally or by a third party, are reviewed by management. Due to the complexity of purchase accounting, final determinations of values can be time consuming and, occasionally, amounts included in the Corporation's consolidated balance sheets and consolidated statements of income are based on preliminary estimates of value. 26 Goodwill and Intangible Assets - Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (Statement 142) addresses the accounting for goodwill and intangible assets subsequent to acquisition. Intangible assets are amortized over their estimated lives. Some intangible assets have indefinite lives and are, therefore, not amortized. All intangible assets must be evaluated for impairment if certain events occur. Any impairment write-downs are recognized as expense in the consolidated income statement. Goodwill is not amortized to expense, but is evaluated at least annually for impairment. The Corporation completes its annual goodwill impairment test as of October 31st of each year. The Corporation tests for impairment by first allocating its goodwill and other assets and liabilities, as necessary, to defined reporting units. A fair value is then determined for each reporting unit. If the fair values of the reporting units exceed their book values, no write-down of the recorded goodwill is necessary. If the fair values are less than the book values, an additional test is necessary to assess the proper carrying value of the goodwill. The Corporation determined that no impairment write-offs were necessary during 2004, 2003 and 2002. Business unit valuation is inherently subjective, with a number of factors based on assumptions and management judgments. Among these are future growth rates for the reporting units, discount rates and earnings capitalization rates. Changes in assumptions and results due to economic conditions, industry factors and reporting unit performance and cash flow projections could result in different assessments of the fair values of reporting units and could result in impairment charges in the future. Income Taxes - The provision for income taxes is based upon income before income taxes, adjusted for the effect of certain tax-exempt income and non-deductible expenses. In addition, certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the applicable enacted marginal tax rate. The Corporation must also evaluate the likelihood that deferred tax assets will be recovered from future taxable income. If any such assets are not likely to be recovered, a valuation allowance must be recognized. The Corporation has determined that a valuation allowance is not required for deferred tax assets as of December 31, 2004, except in the case of deferred tax benefits related to state income tax net operating losses. The assessment of the carrying value of deferred tax assets is based on certain assumptions, changes in which could have a material impact on the Corporation's financial statements. See also Note K, "Income Taxes", in the Notes to Consolidated Financial Statements. RECENT ACCOUNTING PRONOUNCEMENTS Note A, "Summary of Significant Accounting Policies", in the Notes to Consolidated Financial Statements discusses the expected impact of recently issued accounting standards which have not yet been adopted by the Corporation. 27 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the exposure to economic loss that arises from changes in the values of certain financial instruments. The types of market risk exposures generally faced by financial institutions include interest rate risk, equity market price risk, foreign currency risk and commodity price risk. Due to the nature of its operations, only equity market price risk and interest rate risk are significant to the Corporation. Equity Market Price Risk Equity market price risk is the risk that changes in the values of equity investments could have a material impact on the financial position or results of operations of the Corporation. The Corporation's equity investments consist of common stocks of publicly traded financial institutions, U.S. Government and agency stocks and money market mutual funds. The equity investments most susceptible to equity market price risk are the financial institutions stocks, which had a cost basis of approximately $56.9 million and a fair value of $64.3 million at December 31, 2004. Gross unrealized gains in this portfolio were approximately $7.8 million at December 31, 2004. Although the carrying value of the financial institutions stocks accounted only for 0.6% of the Corporation's total assets, the unrealized gains on the portfolio represent a potential source of revenue. The Corporation has a history of realizing gains from this portfolio and, if values were to decline significantly, this revenue source could be lost. Management continuously monitors the fair value of its equity investments and evaluates current market conditions and operating results of the companies. Periodic sale and purchase decisions are made based on this monitoring process. None of the Corporation's equity securities are classified as trading. Future cash flows from these investments are not provided in the table on page 29 as such investments do not have maturity dates. The Corporation has evaluated, based on existing accounting guidance, whether any unrealized losses on individual equity investments constituted "other than temporary" impairment, which would require a write-down through a charge to earnings. Based on the results of such evaluations, the Corporation recorded write-downs of $137,000 in 2004 and $3.3 million in 2003 for specific equity securities which were deemed to exhibit other than temporary impairment in value. Through December 31, 2004, gains of approximately $1.7 million had been realized on the sale of investments previously written down and, as of December 31, 2004, the impaired securities still held in the portfolio had recovered approximately $1.4 million of the original write-down amount. Additional impairment charges may be necessary depending upon the performance of the equity markets in general and the performance of the individual investments held by the Corporation. See also Note C, "Investment Securities", in the Notes to Consolidated Financial Statements. In addition to the risk of changes in the value of its equity portfolio, the Corporation's investment management and trust services revenue could also be impacted by fluctuations in the securities markets. A portion of the Corporation's trust revenue is based on the value of the underlying investment portfolios. If securities markets contract, the Corporation's revenue could be negatively impacted. In addition, the ability of the Corporation to sell its brokerage services is dependent, in part, upon consumers' level of confidence in the outlook for rising securities prices. Interest Rate Risk, Asset/Liability Management and Liquidity Interest rate risk creates exposure in two primary areas. First, changes in rates have an impact on the Corporation's liquidity position and could affect its ability to meet obligations and continue to grow. Second, movements in interest rates can create fluctuations in the Corporation's net interest income and changes in the economic value of its equity. The Corporation employs various management techniques to minimize its exposure to interest rate risk. An Asset/Liability Management Committee (ALCO), consisting of key financial and senior management personnel, meets on a weekly basis. The ALCO is responsible for reviewing the interest rate sensitivity position of the Corporation, approving asset and liability management policies, and overseeing the formulation and implementation of strategies regarding balance sheet positions and earnings. The primary goal of asset/liability management is to address the liquidity and net interest income risks noted above. From a liquidity standpoint, the Corporation must maintain a sufficient level of liquid assets to meet the ongoing cash flow requirements of customers, who, as depositors, may want to withdraw funds or who, as borrowers, need credit availability. Liquidity sources are found on both sides of the balance sheet. Liquidity is provided on a continuous basis through scheduled and unscheduled principal reductions and interest payments on outstanding loans and investments. Liquidity is also provided through the availability of deposits and borrowings. 28 The Corporation's sources and uses of cash were discussed in general terms in the "Overview" section of Management's Discussion. The consolidated statements of cash flows provide additional information. The Corporation generated $146.1 million in cash from operating activities during 2004, mainly due to net income. Investing activities resulted in a net cash inflow of $215.8 million, compared to a net cash outflow of $825.9 million in 2003. In 2004, proceeds from maturities and sales of investment securities exceeded reinvestments in the portfolio and the net increase in the loan portfolio. In 2003, funds provided by investment maturities and increased borrowings were used to purchase additional investment securities. Financing activities resulted in a net cash outflow of $384.7 million in 2004, compared to a net cash inflow of $623.3 in 2003 as funds provided by maturing investments were used to reduce short-term borrowings. Liquidity must also be managed at the Fulton Financial Corporation parent company level. For safety and soundness reasons, banking regulations limit the amount of cash that can be transferred from subsidiary banks to the Parent Company in the form of loans and dividends. Generally, these limitations are based on the subsidiary banks' regulatory capital levels and their net income. Until 2004, the Parent Company has been able to meet its cash needs through normal, allowable dividends and loans. However, as a result of increased acquisition activity and stock repurchase plans, the Parent Company's cash needs have increased, requiring additional sources of funds in 2004. In 2004, the Parent Company entered into a revolving line of credit agreement with an unaffiliated bank. Under the terms of the agreement, the Parent Company can borrow up to $50.0 million (may be increased to $100.0 million upon request) with interest calculated at the one-month London Interbank Offering Rate (LIBOR) plus 0.625%. The credit agreement requires the Corporation to maintain certain financial ratios related to capital strength and earnings. The Corporation was in compliance with all required covenants under the credit agreement as of December 31, 2004. This borrowing arrangement supplements the liquidity available from subsidiaries through dividends and borrowings and provides some flexibility in Parent Company cash management. As of December 31, 2004, $11.9 million had been borrowed on this line. Management continues to monitor the liquidity and capital needs of the Parent Company and will implement appropriate strategies, as necessary, to remain well-capitalized and to meet its cash needs. In addition to its normal recurring and operating cash needs, the Parent Company will also pay cash for a portion of the SVB acquisition, which is expected to be completed in the third quarter of 2005. Based on the terms of the merger agreement, the Parent Company will pay a minimum of approximately $17.0 million and a maximum of approximately $34.0 million to consummate the acquisition. See Note Q, "Mergers and Acquisitions" in the Notes to Consolidated Financial Statements for a summary of the terms of this transaction. At December 31, 2004, liquid assets (defined as cash and due from banks, short-term investments, Federal funds sold, mortgages available for sale, securities available for sale, and non-mortgage-backed securities held to maturity due in one year or less) totaled $2.9 billion, or 26.2% of total assets. This compares to $3.2 billion, or 33.4% of total assets, at December 31, 2003. 29 The following tables set forth the maturities of investment securities at December 31, 2004 and the weighted average yields of such securities (calculated based on historical cost): HELD TO MATURITY (at amortized cost)
MATURING ------------------------------------------------------------------------ After One But After Five But Within One Year Within Five Years Within Ten Years After Ten Years --------------- ----------------- ---------------- --------------- Amount Yield Amount Yield Amount Yield Amount Yield ------ ----- ------ ----- ------ ----- ------ ----- (dollars in thousands) U.S. Government and agency securities .. $ 862 2.25% $3,549 4.13% $2,179 4.29% $313 7.61% State and municipal (1) ................ 8,893 2.98 1,110 6.32 655 8.00 -- -- Other securities ....................... 50 6.91 600 4.13 -- -- -- -- ------ ---- ------ ---- ------ ---- ---- ---- Totals .............................. $9,805 2.93% $5,259 4.59% $2,834 5.15% $313 7.61% ====== ==== ====== ==== ====== ==== ==== ==== Mortgage-backed securities (2) ......... $6,790 6.04% ====== ====
AVAILABLE FOR SALE (at estimated fair value)
MATURING ---------------------------------------------------------------------------- After One But After Five But Within One Year Within Five Years Within Ten Years After Ten Years ------------------ ----------------- ---------------- ---------------- Amount Yield Amount Yield Amount Yield Amount Yield ---------- ----- -------- ----- -------- ----- -------- ----- (dollars in thousands) U.S. Government and agency securities .. $ 82,954 1.97% $ 29,884 3.15% $ 11,934 5.04% $ 4,153 3.39% State and municipal (1) ................ 30,570 4.52 161,760 5.17 98,740 5.09 41,385 8.67 Other securities ....................... 3,327 6.28 378 5.01 2,962 7.19 64,460 7.24 ---------- ---- -------- ---- -------- ---- -------- ---- Totals .............................. $ 116,851 2.76% $192,022 4.85% $113,636 5.14% $109,998 7.63% ========== ==== ======== ==== ======== ==== ======== ==== Mortgage-backed securities (2) ......... $1,722,286 3.45% ========== ====
- ---------- (1) Weighted average yields on tax-exempt securities have been computed on a fully tax-equivalent basis assuming a tax rate of 35 percent. (2) Maturities for mortgage-backed securities are dependent upon the interest rate environment and prepayments on the underlying loans. For the purpose of this table, the entire balance and weighted average rate is shown in one period. The Corporation's investment portfolio consists mainly of mortgage-backed securities which do not have stated maturities. Cash flows from such investments are dependent upon the performance of the underlying mortgage loans, and are generally influenced by the level of interest rates. As rates increase, cash flows generally decrease as prepayments on the underlying mortgage loans decrease. As rates decrease, cash flows generally increase as prepayments increase. The Corporation invests primarily in five and seven year balloon mortgage-backed securities to limit interest rate risk and promote liquidity. 30 The following table presents the approximate contractual maturity and sensitivity of certain loan types, excluding consumer loans and leases, to changes in interest rates as of December 31, 2004:
One One Year Through More Than or Less Five Years Five Years Total ---------- ---------- ---------- ---------- (in thousands) Commercial, financial and agricultural: Floating rate......................... $ 523,570 $ 518,874 $770,183 $1,812,627 Fixed rate............................ 139,925 243,802 76,784 460,511 ---------- ---------- -------- ---------- Total.............................. $ 663,495 $ 762,676 $846,967 $2,273,138 ========== ========== ======== ========== Real-estate - mortgage: Floating rate......................... $ 480,490 $1,222,487 $882,216 $2,585,193 Fixed rate............................ 744,984 671,297 110,863 1,527,144 ---------- ---------- -------- ---------- Total.............................. $1,225,474 $1,893,784 $993,079 $4,112,337 ========== ========== ======== ========== Real-estate - construction: Floating rate......................... $ 292,368 $ 108,896 $ 72,776 $ 474,040 Fixed rate............................ 87,020 28,631 37,095 152,746 ---------- ---------- -------- ---------- Total.............................. $ 379,388 $ 137,527 $109,871 $ 626,786 ========== ========== ======== ==========
From a funding standpoint, the Corporation has been able to rely over the years on a stable base of "core" deposits. Even though the Corporation has experienced notable changes in the composition and interest sensitivity of this deposit base, it has been able to rely on this base to provide needed liquidity. The Corporation also has access to sources of large denomination or jumbo time deposits and repurchase agreements as potential sources of liquidity. However, the Corporation has attempted to minimize its reliance upon these more volatile short-term funding sources and to use them primarily to meet the requirements of its existing customer base or when it is profitable to do so. Contractual maturities of time deposits of $100,000 or more outstanding at December 31, 2004 are as follows (in thousands): Three months or less..................... $114,859 Over three through six months............ 77,021 Over six through twelve months........... 95,626 Over twelve months....................... 248,458 -------- Total................................. $535,964 ========

Each of the Corporation's subsidiary banks is a member of the FHLB and has access to FHLB overnight and term credit facilities. At December 31, 2004, the Corporation had $645.5 million in term advances from the FHLB with an additional $1.3 billion of borrowing capacity (including both short-term funding on its lines of credit and long-term borrowings). This availability, along with Federal funds lines at various correspondent commercial banks, provides the Corporation with additional liquidity. 31 The following table provides information about the Corporation's interest rate sensitive financial instruments. The table presents expected cash flows and weighted average rates for each significant interest rate sensitive financial instrument, by expected maturity period (dollars in thousands).
EXPECTED MATURITY PERIOD -------------------------------------------------------------------- ESTIMATED 2005 2006 2007 2008 2009 BEYOND TOTAL FAIR VALUE ---------- ---------- ---------- ---------- -------- ---------- ----------- ----------- Fixed rate loans (1) ........... $ 747,825 $ 486,830 $ 402,921 $ 261,533 $161,706 $ 325,429 $ 2,386,244 $ 2,480,958 Average rate (2) ............ 6.07% 6.15% 6.08% 6.05% 6.31% 6.38% 6.14% Floating rate loans (1) (3) .... 1,362,108 685,031 538,425 442,696 391,812 1,778,231 5,198,303 5,188,778 Average rate (2) ............ 5.97% 5.83% 6.02% 6.11% 5.70% 4.83% 5.56% Fixed rate investments (1) ..... 577,487 367,723 295,099 429,357 193,217 428,146 2,291,029 2,270,383 Average rate (2) ............ 3.41% 3.77% 4.06% 3.85% 4.07% 4.05% 3.81% Floating rate investments (1) .. -- -- -- 141 -- 9,681 9,822 9,823 Average rate ................ -- -- -- 5.85% -- 3.40% 3.44% Other interest-earning assets .. 195,560 -- -- -- -- -- 195,560 195,560 Average rate ................ 6.09% -- -- -- -- -- 6.09% ---------- ---------- ---------- ---------- -------- ---------- ----------- ----------- TOTAL .......................... $2,882,980 $1,539,584 $1,236,445 $1,133,727 $746,735 $2,541,487 $10,080,958 $10,145,502 AVERAGE RATE ................ 5.40% 5.44% 5.57% 5.24% 5.41% 4.90% 5.29% ---------- ---------- ---------- ---------- -------- ---------- ----------- ----------- Fixed rate deposits (4) ........ $1,521,075 $ 556,945 $ 409,100 $ 96,606 $ 64,590 $ 281,729 $ 2,930,045 $ 2,935,643 Average rate ................ 2.25% 2.97% 3.93% 3.29% 3.82% 4.26% 2.88% Floating rate deposits (5) ..... 1,978,454 192,717 192,717 192,717 192,717 2,216,157 4,965,479 4,965,384 Average rate ................ 1.03% 0.27% 0.27% 0.27% 0.27% 0.19% 0.54% Fixed rate borrowings (6) ...... 154,728 37,874 87,487 221,671 42,405 140,071 684,236 710,215 Average rate ................ 4.37% 3.36% 3.80% 5.01% 4.80% 5.38% 4.68% Floating rate borrowings (7) ... 1,194,524 -- -- -- -- -- 1,194,524 1,194,524 Average rate ................ 1.54% -- -- -- -- -- 1.54% ---------- ---------- ---------- ---------- -------- ---------- ----------- ----------- TOTAL .......................... $4,848,781 $ 787,536 $ 689,304 $ 510,994 $299,712 $2,637,957 $ 9,774,284 $ 9,805,766 AVERAGE RATE ................ 1.75% 2.33% 2.89% 2.89% 1.67% 0.91% 1.71% ---------- ---------- ---------- ---------- -------- ---------- ----------- -----------
- ---------- ASSUMPTIONS: (1) Amounts are based on contractual payments and maturities, adjusted for expected prepayments. (2) Average rates are shown on a fully taxable equivalent basis using an effective tax rate of 35%. (3) Floating rate loans include adjustable rate commercial loans and mortgages which may not reprice immediately upon a change in interest rates. (4) Amounts are based on contractual maturities of fixed rate time deposits. (5) Money market, Super NOW, NOW and savings accounts are placed based on history of deposit flows. (6) Amounts are based on contractual maturities of Federal Home Loan Bank advances, adjusted for possible calls. (7) Amounts are Federal funds purchased and securities sold under agreements to repurchase, which mature in less than 90 days. The preceding table and discussion addressed the liquidity implications of interest rate risk and focused on expected cash flows from financial instruments. Expected maturities, however, do not necessarily reflect the net interest income impact of interest rate changes. Certain financial instruments, such as adjustable rate loans, have repricing periods that differ from expected cash flows. In addition to the interest rate sensitive instruments included in the preceding table, the Corporation also had interest rate swaps with a notional amount of $220 million as of December 31, 2004. These swaps were used to hedge certain long-term fixed rate certificates of deposit held at one of the Corporation's affiliate banks. The terms of the certificates of deposit and the interest rate swaps mirror each other and were committed to simultaneously. Under the terms of the agreements, the Corporation is the fixed rate receiver and the floating rate payer (generally tied to the three month London Interbank Offering Rate, or LIBOR, a common index used for setting rates between financial institutions). The combination of the interest rate swaps and the issuance of the certificates of deposit generates long-term floating rate funding for the Corporation. 32 The Corporation uses three complementary methods to measure and manage interest rate risk. They are static gap analysis, simulation of earnings, and estimates of economic value of equity. Using these measurements in tandem provides a reasonably comprehensive summary of the magnitude of interest rate risk in the Corporation, level of risk as time evolves, and exposure to changes in interest rates. Static gap provides a measurement of repricing risk in the Corporation's balance sheet as of a point in time. This measurement is accomplished through stratification of the Corporation's assets and liabilities into repricing periods. The assets and liabilities in each of these periods are compared for mismatches within that maturity segment. Core deposits not having a contractual maturity are placed into repricing periods based upon historical balance performance. Repricing for mortgage loans and for mortgage-backed securities includes the effect of expected cash flows. Estimated prepayment effects are applied to these balances based upon industry projections for prepayment speeds. The Corporation's policy limits the cumulative 6-month gap to plus or minus 15% of total earning assets. The cumulative 6-month gap as of December 31, 2004 was 1.00. The following is a summary of the interest sensitivity gaps for various time intervals as of December 31, 2004:
0-90 91-180 181-365 Days Days Days ---- ------ ------- ~~GAP.............. 1.00 0.97 1.08 CUMULATIVE GAP... 1.00 1.00 1.01~~
Simulation of net interest income is performed for the next twelve-month period. A variety of interest rate scenarios are used to measure the effects of sudden and gradual movements upward and downward in the yield curve. These results are compared to the results obtained in a flat or unchanged interest rate scenario. Simulation of earnings is used primarily to measure the Corporation's short-term earnings exposure to rate movements. The Corporation's policy limits the potential exposure of net interest income to 10% of the base case net interest income for every 100 basis point "shock" in interest rates. A "shock" is an immediate upward or downward movement of short-term interest rates with changes across the yield curve based upon industry projections. The following table summarizes the expected impact of interest rate shocks on net interest income (due to the current low rates, only the 100 basis shock in a downward scenario is shown):
Annual change Rate Shock in net interest income % Change - ---------- ---------------------- -------- ~~+300 bp + $26.4 million +6.9% +200 bp + $17.6 million +4.6% +100 bp + $12.6 million +3.3% -100 bp - $ 8.6 million -2.2%~~
Economic value of equity estimates the discounted present value of asset cash flows and liability cash flows. Discount rates are based upon market prices for like assets and liabilities. Upward and downward shocks of interest rates are used to determine the comparative effect of such interest rate movements relative to the unchanged environment. This measurement tool is used primarily to evaluate the longer term repricing risks and options in the Corporation's balance sheet. A policy limit of 10% of economic equity may be at risk for every 100 basis point "shock" movement in interest rates. The following table summarizes the expected impact of interest rate shocks on economic value of equity (due to the current low rates, only the 100 basis shock in a downward scenario is shown):
Change in economic Rate Shock value of equity % Change - ---------- ------------------ -------- ~~+300 bp + $36.0 million +2.3% +200 bp + $23.0 million +1.4% +100 bp + $34.2 million +2.1% -100 bp - $52.6 million -3.3%~~
As with any modeling system, the results of the static gap and simulation of net interest income and economic value of equity are a function of the assumptions and projections built into the model. The actual behavior of the financial instruments could differ from these assumptions and projections. 33 COMMON STOCK As of December 31, 2004, the Corporation had 157.2 million shares of $2.50 par value common stock outstanding held by 45,440 shareholders. The common stock of the Corporation is traded on the national market system of the National Association of Securities Dealers Automated Quotation System (NASDAQ) under the symbol FULT. The following table presents the quarterly high and low prices of the Corporation's common stock and per-share cash dividends declared for each of the quarterly periods in 2004 and 2003. Per-share amounts have been retroactively adjusted to reflect the effect of stock dividends and splits.
Price Range --------------- Per-Share High Low Dividend ------ ------ --------- 2004 FIRST QUARTER ... $17.36 $15.89 $0.122 SECOND QUARTER .. 17.31 15.31 0.132 THIRD QUARTER ... 17.52 16.00 0.132 FOURTH QUARTER .. 18.88 16.84 0.132 2003 First Quarter ... $13.86 $12.71 $0.109 Second Quarter .. 16.00 13.61 0.122 Third Quarter ... 16.38 14.66 0.122 Fourth Quarter .. 16.76 15.05 0.122
On June 15, 2004 the Board of Directors approved a stock repurchase plan to repurchase up to 5.0 million shares through December 31, 2004. As of November 30, 2004, the Corporation repurchased approximately 3.1 million of these shares leaving approximately 1.9 million shares still available for repurchase. On December 21, 2004 the Board of Directors approved an extension of the program through June 30, 2005, and increased the total number of shares that could be repurchased to 5.0 million. As of December 31, 2004, no additional shares were repurchased subsequent to the extension of the program. No stock repurchases were made outside publicly announced plans and all were made under the guidelines of Rule 10b-18 and in compliance with Regulation M. The following table presents information related to shares repurchased during the fourth quarter ended December 31, 2004:
TOTAL NUMBER OF MAXIMUM SHARES PURCHASED NUMBER OF SHARES TOTAL AVERAGE AS PART OF A THAT MAY YET BE NUMBER OF PRICE PUBLICLY PURCHASED UNDER SHARES PAID PER ANNOUNCED PLAN THE PLAN OR PERIOD PURCHASED SHARE OR PROGRAM PROGRAM - --------------------- --------- -------- ---------------- ---------------- (10/01/04 - 10/31/04) 85,000 17.30 85,000 3,207,876 (11/01/04 - 11/30/04) 1,345,000 17.58 1,345,000 1,862,876 (12/01/04 - 12/31/04) -- -- -- 5,000,000 --------- ----- --------- --------- Total 1,430,000 17.56 1,430,000 5,000,000
34 EX-99.3 5 w15301exv99w3.txt ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (DECEMBER 31, 2004) . . . EXHIBIT 99.3 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (DECEMBER 31, 2004) CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
December 31 ------------------------ 2004 2003 ----------- ---------- ASSETS Cash and due from banks ................................ $ 278,065 $ 300,966 Interest-bearing deposits with other banks ............. 4,688 4,559 Federal funds sold ..................................... 32,000 -- Mortgage loans held for sale ........................... 158,872 32,761 Investment securities: Held to maturity (estimated fair value of $25,413 in 2004 and $23,739 in 2003) ..................... 25,001 22,993 Available for sale .................................. 2,424,858 2,904,157 Loans, net of unearned income .......................... 7,584,547 6,159,994 Less: Allowance for loan losses ..................... (89,627) (77,700) ----------- ---------- Net Loans ..................................... 7,494,920 6,082,294 ----------- ---------- Premises and equipment ................................. 146,911 120,777 Accrued interest receivable ............................ 40,633 34,407 Goodwill ............................................... 364,019 127,202 Intangible assets ...................................... 25,303 17,594 Other assets ........................................... 164,878 120,959 ----------- ---------- Total Assets .................................. $11,160,148 $9,768,669 =========== ========== LIABILITIES Deposits: Noninterest-bearing ................................. $ 1,507,799 $1,262,214 Interest-bearing .................................... 6,387,725 5,489,569 ----------- ---------- Total Deposits ................................ 7,895,524 6,751,783 ----------- ---------- Short-term borrowings: Federal funds purchased ............................. 676,922 933,000 Other short-term borrowings ......................... 517,602 463,711 ----------- ---------- Total Short-Term Borrowings ................... 1,194,524 1,396,711 ----------- ---------- Accrued interest payable ............................... 27,279 24,579 Other liabilities ...................................... 114,498 78,549 Federal Home Loan Bank advances and long-term debt ..... 684,236 568,730 ----------- ---------- Total Liabilities ............................. 9,916,061 8,820,352 ----------- ---------- SHAREHOLDERS' EQUITY Common stock, $2.50 par value, 400 million shares authorized, 167.8 million shares issued in 2004 and 149.3 million shares issued in 2003 ..... 335,604 284,480 Additional paid-in capital ............................. 1,018,403 648,155 Retained earnings ...................................... 60,924 104,187 Accumulated other comprehensive (loss) income .......... (10,133) 12,267 Treasury stock (10.7 million shares in 2004 and 7.3 million shares in 2003), at cost ................ (160,711) (100,772) ----------- ---------- Total Shareholders' Equity .................... 1,244,087 948,317 ----------- ---------- Total Liabilities and Shareholders' Equity .... $11,160,148 $9,768,669 =========== ==========
See Notes to Consolidated Financial Statements 35 CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
Year Ended December 31 ------------------------------ 2004 2003 2002 -------- -------- -------- INTEREST INCOME Loans, including fees ...................... $396,731 $341,393 $370,318 Investment securities: Taxable ................................. 76,792 77,450 84,139 Tax-exempt .............................. 9,553 10,436 9,835 Dividends ............................... 4,023 4,076 4,066 Other interest income ...................... 6,544 2,176 930 -------- -------- -------- Total Interest Income ................ 493,643 435,531 469,288 INTEREST EXPENSE Deposits ................................... 89,779 94,198 125,394 Short-term borrowings ...................... 15,182 7,373 6,598 Long-term debt ............................. 31,033 29,523 26,227 -------- -------- -------- Total Interest Expense ............... 135,994 131,094 158,219 -------- -------- -------- Net Interest Income .................. 357,649 304,437 311,069 PROVISION FOR LOAN LOSSES .................. 4,717 9,705 11,900 -------- -------- -------- Net Interest Income After Provision for Loan Losses ......... 352,932 294,732 299,169 -------- -------- -------- OTHER INCOME Investment management and trust services ... 34,817 33,898 29,114 Service charges on deposit accounts ........ 39,451 38,500 37,502 Other service charges and fees ............. 20,494 18,860 17,743 Gain on sale of mortgage loans ............. 19,262 18,965 13,941 Investment securities gains ................ 17,712 19,853 8,992 Other ...................................... 7,128 4,294 6,720 -------- -------- -------- Total Other Income ................... 138,864 134,370 114,012 OTHER EXPENSES Salaries and employee benefits ............. 166,026 138,094 129,865 Net occupancy expense ...................... 23,813 19,896 17,705 Equipment expense .......................... 10,769 10,505 11,295 Data processing ............................ 11,430 11,532 11,968 Advertising ................................ 6,943 6,039 6,525 Intangible amortization .................... 4,726 2,059 1,838 Other ...................................... 53,808 45,526 46,850 -------- -------- -------- Total Other Expenses ................. 277,515 233,651 226,046 -------- -------- -------- Income Before Income Taxes ........... 214,281 195,451 187,135 INCOME TAXES ............................... 64,673 59,084 56,181 -------- -------- -------- Net Income ........................... $149,608 $136,367 $130,954 ======== ======== ======== PER-SHARE DATA: Net Income (Basic) ......................... $ 1.00 $ 0.97 $ 0.93 Net Income (Diluted) ....................... 0.99 0.96 0.92 Cash Dividends ............................. 0.518 0.475 0.425
See Notes to Consolidated Financial Statements 36 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
ACCUMULATED OTHER NUMBER OF ADDITIONAL COMPREHENSIVE SHARES COMMON PAID-IN RETAINED (LOSS) TREASURY OUTSTANDING STOCK CAPITAL EARNINGS INCOME STOCK TOTAL ----------- -------- ---------- --------- ------------- --------- ---------- (dollars in thousands) Balance at January 1, 2002..................... 142,313,000 $207,962 $ 546,502 $ 56,269 $ 12,970 $ (11,362) $ 812,341 Comprehensive income: Net income............................... 130,954 130,954 Unrealized gain on securities (net of $14.9 million tax effect)............. 27,676 27,676 Less - reclassification adjustment for gains included in net income (net of $3.1 million tax expense)............. (5,845) (5,845) ---------- Total comprehensive income............ 152,785 ---------- 5 for 4 stock split paid in the form of a 25% stock dividend....................... 51,981 (52,050) (69) Stock issued, including related tax benefits................................. 464,000 (3,195) 6,964 3,769 Stock-based compensation awards............. 2,281 2,281 Acquisition of treasury stock............... (3,439,000) (46,133) (46,133) Cash dividends - $0.425 per share........... (60,095) (60,095) ----------- -------- ---------- --------- -------- --------- ---------- Balance at December 31, 2002................... 139,338,000 259,943 493,538 127,128 34,801 (50,531) 864,879 Comprehensive income: Net income............................... 136,367 136,367 Unrealized loss on securities (net of $5.2 million tax effect).............. (9,630) (9,630) Less - reclassification adjustment for gains included in net income (net of $6.9 million tax expense)............. (12,904) (12,904) ---------- Total comprehensive income............ 113,833 ---------- Stock dividend - 5%......................... 12,998 79,491 (92,526) (37) Stock issued, including related tax benefits................................. 707,000 (3,606) 9,458 5,852 Stock-based compensation awards............. 2,093 2,093 Stock issued for acquisition of Premier Bancorp, Inc............................. 6,058,000 11,539 76,639 88,178 Acquisition of treasury stock............... (4,018,000) (59,699) (59,699) Cash dividends - $0.475 per share........... (66,782) (66,782) ----------- -------- ---------- --------- -------- --------- ---------- Balance at December 31, 2003................... 142,085,000 284,480 648,155 104,187 12,267 (100,772) 948,317 Comprehensive income: Net income............................... 149,608 149,608 Unrealized loss on securities (net of $5.6 million tax effect).............. (10,329) (10,329) Less - reclassification adjustment for gains included in net income (net of $6.2 million tax expense)............. (11,513) (11,513) Minimum pension liability adjustment (net of $300,000 tax effect).......... (558) (558) ---------- Total comprehensive income............ 127,208 ---------- Stock dividend - 5%......................... 15,278 100,247 (115,615) (90) Stock issued, including related tax benefits................................. 1,310,000 (9,141) 19,027 9,886 Stock-based compensation awards............. 3,900 3,900 Stock issued for acquisition of Resource Bankshares Corporation................... 11,287,000 21,498 164,365 185,863 Stock issued for acquisition of First Washington FinancialCorp................. 7,174,000 14,348 110,877 125,225 Acquisition of treasury stock............... (4,706,000) (78,966) (78,966) Cash dividends - $0.518 per share........... (77,256) (77,256) ----------- -------- ---------- --------- -------- --------- ---------- Balance at December 31, 2004................... 157,150,000 $335,604 $1,018,403 $ 60,924 $(10,133) $(160,711) $1,244,087 =========== ======== ========== ========= ======== ========= ==========
See Notes to Consolidated Financial Statements 37 CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
Year Ended December 31 --------------------------------------- 2004 2003 2002 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income .................................................... $ 149,608 $ 136,367 $ 130,954 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses .................................. 4,717 9,705 11,900 Depreciation and amortization of premises and equipment .... 12,409 12,379 12,786 Net amortization of investment security premiums ........... 9,906 19,243 3,974 Deferred income tax expense ................................ 816 4,465 1,705 Gain on sale of investment securities ...................... (17,712) (19,853) (8,992) Gain on sale of mortgage loans ............................. (19,262) (18,965) (13,941) Proceeds from sales of mortgage loans held for sale ........ 1,475,000 871,447 609,726 Originations of mortgage loans held for sale ............... (1,487,303) (813,476) (647,886) Amortization of intangible assets .......................... 4,726 2,059 1,838 Stock-based compensation ................................... 3,900 2,092 2,281 Decrease in accrued interest receivable .................... 22 11,333 713 Decrease (increase) in other assets ........................ 6,895 (14,595) 87 Decrease in accrued interest payable ....................... (759) (6,136) (8,318) Increase (decrease) in other liabilities ................... 3,089 (7,370) (1,580) ----------- ----------- ----------- Total adjustments ....................................... (3,556) 52,328 (35,707) ----------- ----------- ----------- Net cash provided by operating activities ............... 146,052 188,695 95,247 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of securities available for sale ....... 235,332 521,520 67,633 Proceeds from maturities of securities held to maturity .... 8,870 18,146 21,247 Proceeds from maturities of securities available for sale .. 816,834 1,543,992 807,980 Purchase of securities held to maturity .................... (11,402) (8,514) (5,654) Purchase of securities available for sale .................. (269,776) (2,445,592) (1,528,199) (Increase) decrease in short-term investments .............. (9,188) 19,248 (931) Net (increase) decrease in loans ........................... (546,565) (487,147) 44,098 Net cash received from acquisitions ........................ 7,810 17,222 -- Net purchase of premises and equipment ..................... (16,161) (4,730) (10,619) ----------- ----------- ----------- Net cash provided by (used in) investing activities ..... 215,754 (825,855) (604,445) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in demand and savings deposits ................ 293,331 347,665 366,981 Net decrease in time deposits .............................. (174,453) (295,760) (108,257) Addition to long-term debt ................................. 45,000 90,000 100,406 Repayment of long-term debt ................................ (63,509) (157,360) (21,653) Decrease (increase) in short-term borrowings ............... (338,845) 757,964 231,859 Dividends paid ............................................. (74,802) (64,628) (58,954) Net proceeds from issuance of common stock ................. 7,537 5,087 3,267 Acquisition of treasury stock .............................. (78,966) (59,699) (46,133) ----------- ----------- ----------- Net cash (used in) provided by financing activities ..... (384,707) 623,269 467,516 ----------- ----------- ----------- NET DECREASE IN CASH AND DUE FROM BANKs ....................... (22,901) (13,891) (41,682) CASH AND DUE FROM BANKS AT BEGINNING OF YEAR .................. 300,966 314,857 356,539 ----------- ----------- ----------- CASH AND DUE FROM BANKS AT END OF YEAR ........................ $ 278,065 $ 300,966 $ 314,857 =========== =========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during period for: Interest ................................................... $ 136,753 $ 137,230 $ 166,537 Income taxes ............................................... 54,457 48,924 49,621
See Notes to Consolidated Financial Statements 38 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS: Fulton Financial Corporation (Parent Company) is a multi-bank financial holding company which provides a full range of banking and financial services to businesses and consumers through its wholly-owned banking subsidiaries: Fulton Bank, Lebanon Valley Farmers Bank, Swineford National Bank, Lafayette Ambassador Bank, FNB Bank N.A., Hagerstown Trust, Delaware National Bank, The Bank, The Peoples Bank of Elkton, Skylands Community Bank, Premier Bank, Resource Bank and First Washington State Bank as well as its financial services subsidiaries: Fulton Financial Advisors, N.A., and Fulton Insurance Services Group, Inc. In addition, the Parent Company owns the following other non-bank subsidiaries: Fulton Financial Realty Company, Fulton Reinsurance Company, LTD, Central Pennsylvania Financial Corp., FFC Management, Inc. and FFC Penn Square, Inc. Collectively, the Parent Company and its subsidiaries are referred to as the Corporation. The Corporation's primary sources of revenue are interest income on loans and investment securities and fee income on its products and services. Its expenses consist of interest expense on deposits and borrowed funds, provision for loan losses, other operating expenses and income taxes. The Corporation's primary competition is other financial services providers operating in its region. Competitors also include financial services providers located outside the Corporation's geographical market with the growth in electronic delivery systems. The Corporation is subject to the regulations of certain Federal and state agencies and undergoes periodic examinations by such regulatory authorities. The Corporation offers, through its banking subsidiaries, a full range of retail and commercial banking services throughout central and eastern Pennsylvania, Maryland, Delaware, New Jersey and Virginia. Industry diversity is the key to the economic well being of these markets and the Corporation is not dependent upon any single customer or industry. BASIS OF FINANCIAL STATEMENT PRESENTATION: The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States and include the accounts of the Parent Company and all wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements as well as revenues and expenses during the period. Actual results could differ from those estimates. SCOPE OF MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING: Management's report on internal control over financial reporting includes controls at all consolidated entities, except for First Washington FinancialCorp (First Washington) which was acquired on December 31, 2004. Management has not evaluated the internal controls over financial reporting of First Washington and management's conclusion regarding the effectiveness of internal control over financial reporting does not extend to the internal controls of First Washington. See Note Q, "Mergers and Acquisitions", for a summary of the account balances of First Washington included in the consolidated balance sheet of December 31, 2004. INVESTMENTS: Debt securities are classified as held to maturity at the time of purchase when the Corporation has both the intent and ability to hold these investments until they mature. Such debt securities are carried at cost, adjusted for amortization of premiums and accretion of discounts using the effective yield method. The Corporation does not engage in trading activities, however, since the investment portfolio serves as a source of liquidity, most debt securities and all marketable equity securities are classified as available for sale. Securities available for sale are carried at estimated fair value with the related unrealized holding gains and losses reported in shareholders' equity as a component of other comprehensive income, net of tax. Realized security gains and losses are computed using the specific identification method and are recorded on a trade date basis. Securities are evaluated periodically to determine whether a decline in their value is other than temporary. Declines in value that are determined to be other than temporary are recorded as realized losses. LOANS AND REVENUE RECOGNITION: Loan and lease financing receivables are stated at their principal amount outstanding, except for mortgage loans held for sale which are carried at the lower of aggregate cost or market value. Interest income on loans is accrued as earned. Unearned income on lease financing receivables is recognized on a basis which approximates the effective yield method. Premiums and discounts on purchased loans are amortized as an adjustment to interest income using the effective yield method. Accrual of interest income is generally discontinued when a loan becomes 90 days past due as to principal or interest, except for adequately collateralized residential mortgage loans. When interest accruals are discontinued, unpaid interest credited to income is reversed. Nonaccrual loans are restored to accrual status when all delinquent principal and interest become current or the loan is considered secured and in the process of collection. 39 INTEREST RATE SWAPS: As of December 31, 2004, interest rate swaps with a notional amount of $220 million were used to hedge certain long-term fixed rate certificate of deposit liabilities held at one of the Corporation's affiliate banks. The terms of the certificates of deposit and the interest rate swaps mirror each other and were committed to simultaneously. Under the terms of the swap agreements, the Corporation is the fixed rate receiver and the floating rate payer (generally tied to the three month London Interbank Offering Rate, or LIBOR, a common index used for setting rates between financial institutions). The combination of the interest rate swaps and the issuance of the certificates of deposit generates long-term floating rate funding for the Corporation. Both the interest rate swaps and the certificates of deposit are recorded at fair value, with changes in fair value included in the consolidated statements of income as interest expense. Risk management results indicate that the hedges were 98.3% effective as of December 31, 2004, resulting in a favorable adjustment to interest expense to reflect hedge ineffectiveness of $14,000 for the year ended December 31, 2004. LOAN ORIGINATION FEES AND COSTS: Loan origination fees and the related direct origination costs are offset and the net amount is deferred and amortized over the life of the loan using the effective interest method as an adjustment to interest income. For mortgage loans sold, the net amount is included in gain or loss upon the sale of the related mortgage loan. ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is increased by charges to expense and decreased by charge-offs, net of recoveries. Management's periodic evaluation of the adequacy of the allowance for loan losses is based on the Corporation's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrowers' ability to repay, the estimated fair value of the underlying collateral, and current economic conditions. Management believes that the allowance for loan losses is adequate, however, future changes to the allowance may be necessary based on changes in any of these factors. The allowance for loan losses consists of two components - specific allowances allocated to individually impaired loans, as defined by Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" (Statement 114), and allowances calculated for pools of loans under Statement of Financial Accounting Standards No. 5, "Accounting for Contingencies" (Statement 5). Commercial loans and commercial mortgages are reviewed for impairment under Statement 114 if they are both greater than $100,000 and are rated less than "satisfactory" based upon the Corporation's internal credit-rating process. A satisfactory loan does not present more than a normal credit risk based on the strength of the borrower's management, financial condition and trends, and the type and sufficiency of underlying collateral. It is expected that the borrower will be able to satisfy the terms of the loan agreement. A loan is considered to be impaired when, based on current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or at the loan's observable market price or fair value of the collateral if the loan is collateral dependent. An allowance is allocated to an impaired loan if the carrying value exceeds the calculated estimated fair value. All loans not reviewed for impairment are evaluated under Statement 5. In addition to commercial loans and mortgages not meeting the impairment evaluation criteria discussed above, these include residential mortgages, consumer loans, installment loans and lease receivables. These loans are segmented into groups with similar characteristics and an allowance for loan losses is allocated to each segment based on quantitative factors such as recent loss history and qualitative factors such as economic conditions and trends. Loans and lease financing receivables deemed to be a loss are written off through a charge against the allowance for loan losses. Consumer loans are generally charged off when they become 120 days past due if they are not adequately secured by real estate. All other loans are evaluated for possible charge-off when they reach 90 days past due. Such loans or portions thereof are charged-off when it is probable that the balance will not be collected, based on the ability of the borrower to pay and the value of the underlying collateral. Recoveries of loans previously charged off are recorded as an increase to the allowance for loan losses. Past due status is determined based on contractual due dates for loan payments. Lease financing receivables include both open and closed end leases for the purchase of vehicles and equipment. Residual values are set at the inception of the lease and are reviewed periodically for impairment. If the impairment is considered to be other than temporary, the resulting reduction in the net investment in the lease is recognized as a loss in the period. PREMISES AND EQUIPMENT: Premises and equipment are stated at cost, less accumulated depreciation and amortization. The provision for depreciation and amortization is generally computed using the straight-line method over the estimated useful lives of the related assets, which are a maximum of 50 years for buildings and improvements and eight years for furniture and equipment. Leasehold 40 improvements are amortized over the shorter of 15 years or the noncancelable lease term. Interest costs incurred during the construction of major bank premises are capitalized. OTHER REAL ESTATE OWNED: Assets acquired in settlement of mortgage loan indebtedness are recorded as other real estate owned and are included in other assets initially at the lower of the estimated fair value of the asset less estimated selling costs or the carrying amount of the loan. Costs to maintain the assets and subsequent gains and losses on sales are included in other income and other expense. MORTGAGE SERVICING RIGHTS: The estimated fair value of mortgage servicing rights (MSR's) related to loans sold is recorded as an asset upon the sale of such loans. MSR's are amortized as a reduction to servicing income over the estimated lives of the underlying loans. In addition, MSR's are evaluated quarterly for impairment based on prepayment experience and, if necessary, additional amortization is recorded. INCOME TAXES: The provision for income taxes is based upon income before income taxes, adjusted primarily for the effect of tax-exempt income and net credits received from investments in low income housing partnerships. Certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the applicable enacted marginal tax rate. Deferred income tax expenses or benefits are based on the changes in the deferred tax asset or liability from period to period. STOCK-BASED COMPENSATION: The Corporation accounts for its stock options in accordance with Statement of Financial Accounting Standards No. 123R, "Share-Based Payment" (Statement 123R). Statement 123R requires public companies to recognize compensation expense related to stock-based equity awards in their income statements. See Note M, "Stock-Based Compensation Plans and Shareholders' Equity" for more information. NET INCOME PER SHARE: The Corporation's basic net income per share is calculated as net income divided by the weighted average number of shares outstanding. For diluted net income per share, net income is divided by the weighted average number of shares outstanding plus the incremental number of shares added as a result of converting common stock equivalents, calculated using the treasury stock method. The Corporation's common stock equivalents consist solely of outstanding stock options. Excluded from the calculation were anti-dilutive options totaling 599,000 in 2002. 41 A reconciliation of the weighted average shares outstanding used to calculate basic net income per share and diluted net income per share follows. There were no adjustments to net income to arrive at diluted net income per share.
2004 2003 2002 ------- ------- ------- (in thousands) Weighted average shares outstanding (basic)........... 149,294 140,335 141,445 Impact of common stock equivalents.................... 1,614 1,176 1,012 ------- ------- ------- Weighted average shares outstanding (diluted)......... 150,908 141,511 142,457 ======= ======= =======
The Corporation declared a 5-for-4 stock split on April 13, 2005. The stock split was paid in the form of a 25% stock dividend on June 8, 2005 to shareholders of record as of May 17, 2005. Share and per-share information presented in this report have been restated to reflect the impact of this stock split. DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION: The Corporation does not have any operating segments which require disclosure of additional information. While the Corporation owns thirteen separate banks, each engages in similar activities, provides similar products and services, and operates in the same general geographical area. The Corporation's non-banking activities are immaterial and, therefore, separate information has not been disclosed. FINANCIAL GUARANTEES: Financial guarantees, which consist primarily of standby and commercial letters of credit, are accounted for by recognizing a liability equal to the fair value of the guarantees and crediting the liability to income over the term of the guarantee. Fair value is estimated using the fees currently charged to enter into similar agreements with similar terms. BUSINESS COMBINATIONS AND INTANGIBLE ASSETS: The Corporation accounts for its acquisitions using the purchase accounting method as required by Statement of Financial Accounting Standards No. 141, "Business Combinations". Purchase accounting requires the total purchase price to be allocated to the estimated fair values of assets and liabilities acquired, including certain intangible assets that must be recognized. Typically, this results in a residual amount in excess of the net fair values, which is recorded as goodwill. As required by Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (Statement 142), goodwill is not amortized to expense, but is tested for impairment at least annually. Write-downs of the balance, if necessary as a result of the impairment test, are to be charged to the results of operations in the period in which the impairment is determined. The Corporation performed its annual tests of goodwill impairment on October 31 of each year. Based on the results of these tests the Corporation concluded that there was no impairment and no write-downs were recorded. If certain events occur which might indicate goodwill has been impaired, the goodwill is tested when such events occur. In October 2002, the FASB issued Statement of Financial Accounting Standards No. 147, "Acquisitions of Certain Financial Institutions" (Statement 147) which allowed the excess purchase price recorded in qualifying branch acquisitions to be treated in the same manner as Statement 142 goodwill. Upon adoption of Statement 147, its provisions were applied retroactively to the January 1, 2002 adoption date for Statement 142. As a result of adopting Statement 147, the Corporation was not required to recognize $1.0 million of goodwill amortization in 2002 ($677,000, net of taxes), for a net benefit of $0.01 per share (basic and diluted). See Note F, "Goodwill and Intangible Assets" for additional disclosures. VARIABLE INTEREST ENTITIES: FASB Interpretation No. 46, "Consolidation of Variable Interest Entities - An Interpretation of ARB No. 51" (FIN 46), provides guidance on when to consolidate certain Variable Interest Entities (VIE's) in the financial statements of the Corporation. VIE's are entities in which equity investors do not have a controlling financial interest or do not have sufficient equity at risk for the entity to finance activities without additional financial support from other parties. Under FIN 46, a company must consolidate a VIE if the company has a variable interest that will absorb a majority of the VIE's losses, if they occur, and/or receive a majority of the VIE's residual returns, if they occur. For the Corporation, FIN 46 affects corporation-obligated mandatorily redeemable capital securities of subsidiary trust (Trust Preferred Securities) and its investments in low and moderate income housing partnerships. Trust Preferred Securities had historically been presented as minority interests in the Corporation's consolidated balance sheet. With the adoption of the related FIN 46 provisions, as interpreted by the Securities and Exchange Commission, Trust Preferred Securities were deconsolidated from the consolidated balance sheet as of December 31, 2004 and 2003. The impact of this deconsolidation was to increase long-term debt and reduce corporation-obligated mandatorily redeemable capital securities of subsidiary trust by $34.0 42 million. There was no impact of the deconsolidation on net income or net income per share. Prospectively, expense related to these issuances will be recorded as interest expense on long-term debt rather than minority interest expense. Current regulatory capital rules allow Trust Preferred Securities to be included as a component of regulatory capital. This treatment has continued despite the deconsolidation of these instruments for financial reporting purposes. If banking regulators make a determination that Trust Preferred Securities can no longer be considered in regulatory capital, the securities become callable and the Corporation may redeem them. See additional disclosures in Note I, "Short-Term Borrowings and Long-term Debt". Investments in low and moderate income partnerships (LIH Investments) are amortized under the effective interest method over the life of the Federal income tax credits generated as a result of such investments, generally ten years. At December 31, 2004 and 2003, the Corporation's LIH Investments totaled $52.0 million and $40.0 million, respectively. The net income tax benefit associated with these investments was $4.5 million in 2004, $4.0 million in 2003 and 2002. Based on its review of FIN 46, the Corporation did not consolidate any of its LIH Investments as of December 31, 2004 or 2003. ACCOUNTING FOR CERTAIN LOANS OR DEBT SECURITIES ACQUIRED IN A TRANSFER: In December 2003, the Accounting Standards Executive Committee issued Statement of Position 03-3 (SOP 03-3), "Accounting for Certain Loans or Debt Securities Acquired in a Transfer". SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities acquired in a transfer, including business combinations, if those differences are attributable, at least in part, to credit quality. SOP 03-3 is effective for loans or debt securities acquired in fiscal years beginning after December 15, 2004. The Corporation intends to adopt the provisions of SOP 03-3 effective January 1, 2005, and does not expect the initial implementation to have a material effect on the Corporation's financial condition or results of operations. OTHER-THAN-TEMPORARY IMPAIRMENT: In the second quarter of 2004, the Emerging Issues Task Force (EITF) released EITF Issue 03-01, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments" (EITF 03-01), which provides guidance for evaluating whether an investment is other-than-temporarily impaired and requires certain disclosures with respect to these investments. In September 2004, the FASB delayed the effective date of the measurement and recognition guidance of EITF 03-01 from the third calendar quarter of 2004 to a date to be determined upon the issuance of a final FASB Staff Position. The Corporation continues to apply the measurement and recognition criteria of existing authoritative literature in evaluating its investments for other than temporary impairment. Management does not expect EITF 03-01 to have a material impact on its financial condition or results of operations. RECLASSIFICATIONS AND RESTATEMENTS: Certain amounts in the 2003 and 2002 consolidated financial statements and notes have been reclassified to conform to the 2004 presentation. All share and per-share data have been restated to reflect the impact of the 5-for-4 stock split paid in June 2005 and the 5% stock dividend paid in June 2004. NOTE B - RESTRICTIONS ON CASH AND DUE FROM BANKS The Corporation's subsidiary banks are required to maintain reserves, in the form of cash and balances with the Federal Reserve Bank, against their deposit liabilities. The average amount of such reserves during 2004 and 2003 was approximately $100.8 million and $94.4 million, respectively. 43 NOTE C - INVESTMENT SECURITIES The following tables present the amortized cost and estimated fair values of investment securities as of December 31:
GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---------- ---------- ---------- ---------- (in thousands) 2004 HELD TO MATURITY U.S. Government and agency securities ................... $ 6,903 $ 78 $ (55) $ 6,926 State and municipal securities .. 10,658 65 -- 10,723 Corporate debt securities ....... 650 1 -- 651 Mortgage-backed securities ...... 6,790 323 -- 7,113 ---------- ------- -------- ---------- $ 25,001 $ 467 $ (55) $ 25,413 ========== ======= ======== ========== 2004 AVAILABLE FOR SALE Equity securities ............... $ 163,249 $ 7,822 $ (1,006) $ 170,065 U.S. Government and agency securities ................... 128,829 144 (48) 128,925 State and municipal securities .. 328,726 4,350 (621) 332,455 Corporate debt securities ....... 68,215 3,053 (141) 71,127 Mortgage-backed securities ...... 1,750,080 1,427 (29,221) 1,722,286 ---------- ------- -------- ---------- $2,439,099 $16,796 $(31,037) $2,424,858 ========== ======= ======== ========== 2003 HELD TO MATURITY U.S. Government and agency securities ................... $ 7,728 $ 158 $ (41) $ 7,845 State and municipal securities .. 4,462 87 -- 4,549 Corporate debt securities ....... 640 1 -- 641 Mortgage-backed securities ...... 10,163 541 -- 10,704 ---------- ------- -------- ---------- $ 22,993 $ 787 $ (41) $ 23,739 ========== ======= ======== ========== 2003 AVAILABLE FOR SALE Equity securities ............... $ 197,262 $15,597 $ (507) $ 212,352 U.S. Government and agency securities ................... 82,178 261 -- 82,439 State and municipal securities .. 291,244 7,115 (329) 298,030 Corporate debt securities ....... 28,772 292 (408) 28,656 Mortgage-backed securities ...... 2,285,845 9,109 (12,274) 2,282,680 ---------- ------- -------- ---------- $2,885,301 $32,374 $(13,518) $2,904,157 ========== ======= ======== ==========
44 The amortized cost and estimated fair value of debt securities at December 31, 2004 by contractual maturity are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Held to Maturity Available for Sale ---------------------- ----------------------- Amortized Estimated Amortized Estimated Cost Fair Value Cost Fair Value --------- ---------- ---------- ---------- (in thousands) Due in one year or less ........... $ 9,805 $ 9,804 $ 116,720 $ 116,851 Due from one year to five years ... 5,259 5,308 190,051 192,022 Due from five years to ten years .. 2,834 2,798 112,882 113,636 Due after ten years ............... 313 390 106,117 109,998 ------- ------- ---------- ---------- 18,211 18,300 525,770 532,507 Mortgage-backed securities ........ 6,790 7,113 1,750,080 1,722,286 ------- ------- ---------- ---------- $25,001 $25,413 $2,275,850 $2,254,793 ======= ======= ========== ==========
Gains totaling $14.8 million, $17.3 million and $7.4 million were realized on the sale of equity securities during 2004, 2003 and 2002, respectively. Gains totaling $3.1 million, $5.9 million and $1.6 million were realized on the sale of available for sale debt securities during 2004, 2003 and 2002, respectively. Losses of $137,000, and $3.3 million were recognized in 2004 and 2003 respectively, for equity investments exhibiting other than temporary impairment. Securities carried at $1.2 billion at December 31, 2004 and 2003 were pledged as collateral to secure public and trust deposits and customer and brokered repurchase agreements. The following table presents the gross unrealized losses and fair values of investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2004:
Less Than 12 months 12 Months or Longer Total ----------------------- ----------------------- ----------------------- Estimated Unrealized Estimated Unrealized Estimated Unrealized Fair Value Losses Fair Value Losses Fair Value Losses ---------- ---------- ---------- ---------- ---------- ---------- (in thousands) U.S. Government and agency securities .. $ 67,763 $ (103) $ -- $ -- $ 67,763 $ (103) State and municipal securities ......... 66,794 (554) 2,392 (67) 69,186 (621) Corporate debt securities .............. 2,296 (15) 8,118 (126) 10,414 (141) Mortgage-backed securities ............. 896,845 (13,498) 632,216 (15,723) 1,529,061 (29,221) ---------- -------- -------- -------- ---------- -------- Total debt securities ............... 1,033,698 (14,170) 642,726 (15,916) 1,676,424 (30,086) Equity securities ...................... 13,063 (810) 10,469 (196) 23,532 (1,006) ---------- -------- -------- -------- ---------- -------- Total ............................... $1,046,761 $(14,980) $653,195 $(16,112) $1,699,956 $(31,092) ========== ======== ======== ======== ========== ========
Mortgage-backed securities consist of five and seven-year balloon pools issued by the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal National Mortgage Association (FNMA). The majority of the securities shown in the above table were purchased during 2003 when mortgage rates were at historical lows. Unrealized losses on these securities at December 31, 2004 resulted from an increase in market rates since the securities were purchased. Because FHLMC and FNMA guarantee the payment of principal, the credit risk for these securities is minimal and, as such, no impairment write-offs were considered to be necessary. 45 NOTE D - LOANS AND ALLOWANCE FOR LOAN LOSSES Gross loans are summarized as follows as of December 31:
2004 2003 ---------- ---------- (in thousands) Commercial - industrial and financial ... $1,946,962 $1,594,451 Commercial - agricultural ............... 326,176 354,517 Real-estate - commercial mortgage ....... 2,461,016 1,992,650 Real-estate - commercial construction ... 348,846 264,129 Real-estate - residential mortgage ...... 543,072 434,568 Real-estate - residential construction .. 277,940 42,979 Real estate - home equity ............... 1,108,249 890,044 Consumer ................................ 506,290 516,587 Leasing and other ....................... 77,767 84,056 Deferred loan fees, net of costs ........ (4,972) (6,410) ---------- ---------- 7,591,346 6,167,571 Unearned income ......................... (6,799) (7,577) ---------- ---------- $7,584,547 $6,159,994 ========== ==========
Changes in the allowance for loan losses were as follows for the years ended December 31:
2004 2003 2002 ------- -------- -------- (in thousands) Balance at beginning of year ................ $77,700 $ 71,920 $ 71,872 Loans charged off ........................... (8,877) (13,228) (15,670) Recoveries of loans previously charged off .. 4,520 3,829 3,818 ------- -------- -------- Net loans charged off .................... (4,357) (9,399) (11,852) Provision for loan losses ................... 4,717 9,705 11,900 Allowance purchased ......................... 11,567 5,474 -- ------- -------- -------- Balance at end of year ...................... $89,627 $ 77,700 $ 71,920 ======= ======== ========
The following table presents non-performing assets as of December 31:
2004 2003 ------- ------- (in thousands) Nonaccrual loans .............................. $22,574 $22,422 Accruing loans greater than 90 days past due .. 8,318 9,609 Other real estate owned ....................... 2,209 585 ------- ------- $33,101 $32,616 ======= =======
Interest of approximately $1.5 million, $1.8 million and $1.7 million was not recognized as interest income due to the non-accrual status of loans during 2004, 2003 and 2002, respectively. The recorded investment in loans that were considered to be impaired as defined by Statement 114 was $130.6 million and $78.2 million at December 31, 2004 and 2003, respectively. At December 31, 2004 and 2003, $6.6 million and $8.9 million of impaired loans were included in non-accrual loans, respectively. At December 31, 2004 and 2003, impaired loans had related allowances for loan losses of $41.6 million and $25.8 million, respectively. There were no impaired loans in 2004 and 2003 that did not have a related 46 allowance for loan losses. The average recorded investment in impaired loans during the years ended December 31, 2004, 2003 and 2002 was approximately $108.0 million, $78.4 million, and $40.2 million, respectively. The Corporation applies all payments received on non-accruing impaired loans to principal until such time as the principal is paid off, after which time any additional payments received are recognized as interest income. Payments received on accruing impaired loans are applied to principal and interest according to the original terms of the loan. The Corporation recognized interest income of approximately $5.6 million, $3.9 million and $1.7 million on impaired loans in 2004, 2003 and 2002, respectively. The Corporation has extended credit to the officers and directors of the Corporation and to their associates. Related-party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectibility. The aggregate dollar amount of these loans, including unadvanced commitments, was $209.8 million and $170.1 million at December 31, 2004 and 2003, respectively. During 2004, $48.4 million of new advances were made and repayments totaled $18.7 million. First Washington and Resource added $10.0 million to related party loans. The total portfolio of mortgage loans serviced by the Corporation for unrelated third parties was $1.1 billion at December 31, 2004 and 2003. NOTE E - PREMISES AND EQUIPMENT The following is a summary of premises and equipment as of December 31:
2004 2003 --------- --------- (in thousands) Land ............................................. $ 25,253 $ 18,626 Buildings and improvements ....................... 149,700 131,971 Furniture and equipment .......................... 105,406 92,468 Construction in progress ......................... 10,967 1,909 --------- --------- 291,326 244,974 Less: Accumulated depreciation and amortization .. (144,415) (124,197) --------- --------- $ 146,911 $ 120,777 ========= =========
NOTE F - GOODWILL AND INTANGIBLE ASSETS The following table summarizes the changes in goodwill:
2004 2003 2002 -------- -------- ------- (in thousands) Balance at beginning of year ..................... $127,202 $ 61,048 $38,900 Goodwill acquired ................................ 236,817 66,154 -- Reclassified goodwill ............................ -- -- 21,300 Reversal of negative goodwill .................... -- -- 848 -------- -------- ------- Balance at end of year ........................... $364,019 $127,202 $61,048 ======== ======== =======
Reclassified goodwill consists of certain branch acquisition unidentifiable intangible assets that were accounted for as unidentifiable intangible assets prior to the adoption of Statement 147. Upon adoption of Statement 147, previous acquisitions giving rise to unidentifiable intangible assets were reviewed to determine if they constituted the acquisition of a business. Upon adoption of Statement 147 retroactively to January 1, 2002, certain of these assets were reclassified to goodwill. See Note Q, "Mergers and Acquisitions" for information regarding goodwill acquired in 2004 and 2003. 47 The cumulative effect of adopting Statement 142 was $848,000, representing the reversal of negative goodwill balances existing at January 1, 2002. This has been presented as other income in the consolidated statement of income. The following table adjusts net income and net income per share for this amount (in thousands, except per-share amounts):
2004 2003 2002 -------- -------- -------- Net income, as reported .................... $149,608 $136,367 $130,954 Amortization of goodwill, net of taxes ..... -- -- -- Reversal of negative goodwill .............. -- -- (848) -------- -------- -------- Net income, as adjusted .................... $149,608 $136,367 $130,106 ======== ======== ======== Basic net income per share, as reported .... $ 1.00 $ 0.97 $ 0.93 Amortization of goodwill, net of taxes ..... -- -- -- Reversal of negative goodwill .............. -- -- (0.01) -------- -------- -------- Basic net income per share, as adjusted .... $ 1.00 $ 0.97 $ 0.92 ======== ======== ======== Diluted net income per share, as reported .. $ 0.99 $ 0.96 $ 0.92 Amortization of goodwill, net of taxes ..... -- -- -- Reversal of negative goodwill .............. -- -- (0.01) -------- -------- -------- Diluted net income per share, as adjusted .. $ 0.99 $ 0.96 $ 0.91 ======== ======== ========
- ---------- Note: Adjusted per share amounts do not sum in all cases due to rounding. The following table summarizes intangible assets at December 31:
2004 2003 -------------------------------- -------------------------------- ACCUMULATED Accumulated GROSS AMORTIZATION NET Gross Amortization Net ------- ------------ ------- ------- ------------ ------- (in thousands) Amortizing: Core deposit .............. $27,678 $ (7,418) $20,260 $19,540 $(4,320) $15,220 Non-compete ............... 475 (40) 435 -- -- -- Unidentifiable ............ 7,706 (3,998) 3,708 4,784 (2,410) 2,374 ------- -------- ------- ------- ------- ------- Total amortizing ....... 35,859 (11,456) 24,403 24,324 (6,730) 17,594 Non-amortizing - Trade name .. 900 -- 900 -- -- -- ------- -------- ------- ------- ------- ------- $36,759 $(11,456) $25,303 $24,324 $(6,730) $17,594 ======= ======== ======= ======= ======= =======
Core deposit intangible assets are amortized using an accelerated method over the estimated remaining life of the acquired core deposits. As of December 31, 2004, these assets had a weighted average remaining life of approximately eight years. Unidentifiable intangible assets related to branch acquisitions are amortized on a straight-line basis over ten years. Non-compete intangible assets are being amortized on a straight-line basis over five years, which is the term of the underlying contracts. Amortization expense related to intangible assets totaled $4.7 million, $2.1 million and $1.8 million in 2004, 2003 and 2002, respectively. 48 Amortization expense for the next five years is expected to be as follows (in thousands):
Year ---- ~~2005......... $4,639 2006......... 4,266 2007......... 3,663 2008......... 3,081 2009......... 2,791~~
NOTE G - MORTGAGE SERVICING RIGHTS The following table summarizes the changes in mortgage servicing rights (MSR's), which are included in other assets in the consolidated balance sheets:
2004 2003 2002 ------- ------- ------- (in thousands) Balance at beginning of year ............... $ 8,396 $ 6,233 $3,271 Originations of mortgage servicing rights .. 2,138 4,992 3,839 Amortization expense ....................... (2,377) (2,829) (877) ------- ------- ------ Balance at end of year ..................... $ 8,157 $ 8,396 $6,233 ======= ======= ======
MSR's represent the economic value to be derived by the Corporation based upon its existing contractual rights to service mortgage loans that have been sold. Accordingly, to the extent mortgage loan prepayments occur the value of MSR's can be impacted. The Corporation estimates the fair value of its MSR's by discounting the estimated cash flows of servicing revenue, net of costs, over the expected life of the underlying loans at a discount rate commensurate with the risk associated with these assets. Expected life is based on industry prepayment projections for mortgage-backed securities with rates and terms comparable to the loans underlying the Corporation's MSR's. The estimated fair value of the Corporation's MSR's was approximately $8.5 million and $8.4 million at December 31, 2004 and 2003, respectively. Estimated MSR's amortization expense for the next five years, based on balances at December 31, 2004 and the expected remaining lives of the underlying loans follows (in thousands):
Year ---- ~~2005......... $1,931 2006......... 1,730 2007......... 1,499 2008......... 1,236 2009......... 938~~
49 NOTE H - DEPOSITS Deposits consisted of the following as of December 31:
2004 2003 ---------- ---------- (in thousands) Noninterest-bearing demand ......... $1,507,799 $1,262,214 Interest-bearing demand ............ 1,501,476 1,289,946 Savings and money market accounts .. 1,917,203 1,751,475 Time deposits ...................... 2,969,046 2,448,148 ---------- ---------- $7,895,524 $6,751,783 ========== ==========
Included in time deposits were certificates of deposit equal to or greater than $100,000 of $536.0 million and $451.0 million at December 31, 2004 and 2003, respectively. The scheduled maturities of time deposits as of December 31, 2004 were as follows (in thousands):
Year ---- 2005......... $1,503,631 2006......... 555,230 2007......... 426,784 2008......... 103,273 2009......... 70,549 Thereafter... 309,579 ---------- $2,969,046 ==========
NOTE I - SHORT-TERM BORROWINGS AND LONG-TERM DEBT Short-term borrowings at December 31, 2004, 2003, and 2002 and the related maximum amounts outstanding at the end of any month in each of the three years are presented below. The securities underlying the repurchase agreements remain in available for sale investment securities.
December 31 Maximum Outstanding ---------------------------------- ------------------------------ 2004 2003 2002 2004 2003 2002 ---------- ---------- -------- -------- -------- -------- (in thousands) Federal funds purchased ......................... $ 676,922 $ 933,000 $330,000 $849,200 $933,000 $330,000 Securities sold under agreements to repurchase .. 500,206 408,697 297,556 708,830 429,819 347,248 FHLB overnight repurchase agreements ............ -- 50,000 -- -- 50,000 -- Revolving line of credit ........................ 11,930 -- -- 26,000 -- -- Other ........................................... 5,466 5,014 4,638 5,807 6,387 5,640 ---------- ---------- -------- $1,194,524 $1,396,711 $632,194 ========== ========== ========
In 2004, the Corporation entered into a $50.0 million revolving line of credit agreement with an unaffiliated bank that provides for interest to be paid on outstanding balances at the one-month London Interbank Offering Rate (LIBOR) plus 0.625%. The credit agreement requires the Corporation to maintain certain financial ratios related to capital strength and earnings. The Corporation was in compliance with all required covenants under the credit agreement as of December 31, 2004. 50 The following table presents information related to securities sold under agreements to repurchase:
December 31 ------------------------------ 2004 2003 2002 -------- -------- -------- (dollars in thousands) Amount outstanding at December 31 ................ $500,206 $408,697 $297,556 Weighted average interest rate at year end ....... 1.03% 0.72% 1.43% Average amount outstanding during the year ....... $531,196 $351,302 $297,453 Weighted average interest rate during the year ... 0.97% 0.83% 1.43%
Federal Home Loan Bank advances and long-term debt included the following as of December 31:
2004 2003 -------- -------- (in thousands) Federal Home Loan Bank advances ..................... $645,461 $532,344 Junior subordinated deferrable interest debentures .. 34,022 33,509 Other long-term debt ................................ 4,753 2,877 -------- -------- $684,236 $568,730 ======== ========
The Parent Company owns all of the common stock of four Delaware business trusts, which have issued Trust Preferred Securities in conjunction with the Parent Company issuing junior subordinated deferrable interest debentures to the trusts. The terms of the junior subordinated deferrable interest debentures are the same as the terms of the Trust Preferred Securities. The Parent Company's obligations under the debentures constitute a full and unconditional guarantee by the Parent Company of the obligations of the trusts. Trust Preferred securities are redeemable on specified dates, or earlier if the deduction of interest for Federal income taxes is prohibited, the Trust Preferred Securities no longer qualify as Tier I capital, or if certain other contingencies arise. The Trust Preferred Securities must be redeemed upon maturity. The following table details the terms of the debentures (dollars in thousands):
RATE AT FIXED/ DECEMBER 31, DEBENTURES ISSUED TO VARIABLE 2004 AMOUNT MATURITY CALLABLE -------------------- -------- ------------ ------- -------- -------- Premier Capital Trust........ Fixed 8.57% $10,310 8/15/28 8/15/08 PBI Capital Trust II......... Variable 5.73% 15,464 11/7/32 11/7/07 Resource Capital Trust II.... Variable 5.61% 5,155 12/8/31 12/8/06 Resource Capital Trust III... Variable 5.73% 3,093 11/7/32 11/7/07 ------- $34,022 =======
Federal Home Loan Bank advances mature through May 2014 and carry a weighted average interest rate of 4.61%. As of December 31, 2004, the Corporation had an additional borrowing capacity of approximately $1.3 billion with the Federal Home Loan Bank. Advances from the Federal Home Loan Bank are secured by Federal Home Loan Bank stock, qualifying residential mortgages, investments and other assets. 51 The following table summarizes the scheduled maturities of Federal Home Loan Bank advances and long-term debt as of December 31, 2004 (in thousands):
Year ---- 2005......... $126,230 2006......... 33,706 2007......... 70,302 2008......... 212,359 2009......... 68,988 Thereafter... 172,651 -------- $684,236 ========
NOTE J - REGULATORY MATTERS Dividend and Loan Limitations The dividends that may be paid by subsidiary banks to the Parent Company are subject to certain legal and regulatory limitations. Under such limitations, the total amount available for payment of dividends by subsidiary banks was approximately $230 million at December 31, 2004. Under current Federal Reserve regulations, the subsidiary banks are limited in the amount they may loan to their affiliates, including the Parent Company. Loans to a single affiliate may not exceed 10%, and the aggregate of loans to all affiliates may not exceed 20% of each bank subsidiary's regulatory capital. At December 31, 2004, the maximum amount available for transfer from the subsidiary banks to the Parent Company in the form of loans and dividends was approximately $310 million. Regulatory Capital Requirements The Corporation's subsidiary banks are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Corporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the subsidiary banks must meet specific capital guidelines that involve quantitative measures of the subsidiary banks' assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The subsidiary banks' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the subsidiary banks to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets (as defined in the regulations). Management believes, as of December 31, 2004, that all of its bank subsidiaries meet the capital adequacy requirements to which they are subject. As of December 31, 2004 and 2003, the Corporation's seven significant subsidiaries, Fulton Bank, Lebanon Valley Farmers Bank, Lafayette Ambassador Bank, The Bank, Premier Bank, Resource Bank and First Washington State Bank were well capitalized under the regulatory framework for prompt corrective action based on their capital ratio calculations. To be categorized as well-capitalized, these banks must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since December 31, 2004 that management believes have changed the institutions' categories. 52 The following tables present the total risk-based, Tier I risk-based and Tier I leverage requirements for the Corporation and its significant subsidiaries.
For Capital Actual Adequacy Purposes Well-Capitalized ---------------- ----------------- ---------------- AS OF DECEMBER 31, 2004 Amount Ratio Amount Ratio Amount Ratio ----------------------- -------- ----- -------- ----- -------- ----- (dollars in thousands) Total Capital (to Risk Weighted Assets): Corporation........................... $981,000 11.8% $667,522 8.0% $834,402 10.0% Fulton Bank........................... 401,961 11.2 286,697 8.0 358,372 10.0 Lebanon Valley Farmers Bank........... 59,860 11.6 41,254 8.0 51,567 10.0 Lafayette Ambassador Bank............. 95,631 11.4 67,124 8.0 83,905 10.0 The Bank.............................. 89,891 11.1 64,969 8.0 81,211 10.0 Premier Bank.......................... 45,770 13.0 28,218 8.0 35,272 10.0 Resource Bank......................... 83,274 11.1 60,241 8.0 75,302 10.0 First Washington State Bank........... 38,183 12.7 24,142 8.0 30,177 10.0 Tier I Capital (to Risk Weighted Assets): Corporation........................... $888,526 10.6% $333,761 4.0% $500,641 6.0% Fulton Bank........................... 366,633 10.2 143,349 4.0 215,023 6.0 Lebanon Valley Farmers Bank........... 55,051 10.7 20,627 4.0 30,940 6.0 Lafayette Ambassador Bank............. 86,456 10.3 33,562 4.0 50,343 6.0 The Bank.............................. 81,252 10.0 32,485 4.0 48,727 6.0 Premier Bank.......................... 39,858 11.3 14,109 4.0 21,163 6.0 Resource Bank......................... 75,503 10.0 30,121 4.0 45,181 6.0 First Washington State Bank........... 34,729 11.5 12,071 4.0 18,106 6.0 Tier I Capital (to Average Assets): Corporation........................... $888,526 8.8% $304,392 3.0% $507,319 5.0% Fulton Bank........................... 366,633 8.4 130,290 3.0 217,150 5.0 Lebanon Valley Farmers Bank........... 55,051 7.2 23,048 3.0 38,413 5.0 Lafayette Ambassador Bank............. 86,456 7.4 35,166 3.0 58,609 5.0 The Bank.............................. 81,252 7.7 31,762 3.0 52,937 5.0 Premier Bank.......................... 39,858 8.6 13,903 3.0 23,172 5.0 Resource Bank......................... 75,503 7.7 29,304 3.0 48,839 5.0 First Washington State Bank........... 34,729 7.2 14,564 3.0 24,273 5.0
53
For Capital Actual Adequacy Purposes Well-Capitalized ---------------- ----------------- ---------------- AS OF DECEMBER 31, 2003 Amount Ratio Amount Ratio Amount Ratio - ----------------------- -------- ----- -------- ----- -------- ----- (dollars in thousands) Total Capital (to Risk Weighted Assets): Corporation .............................. $897,893 12.7% $564,503 8.0% $705,629 10.0% Fulton Bank .............................. 363,827 10.4 278,843 8.0 348,553 10.0 Lebanon Valley Farmers Bank .............. 60,714 11.4 42,428 8.0 53,035 10.0 Lafayette Ambassador Bank ................ 89,046 10.7 66,405 8.0 83,007 10.0 The Bank ................................. 78,769 11.1 56,583 8.0 70,729 10.0 Premier Bank ............................. 40,582 11.4 29,223 8.0 36,529 10.0 Tier I Capital (to Risk Weighted Assets): Corporation .............................. $813,402 11.5% $282,252 4.0% $423,378 6.0% Fulton Bank .............................. 328,868 9.4 139,421 4.0 209,132 6.0 Lebanon Valley Farmers Bank .............. 55,142 10.4 21,214 4.0 31,821 6.0 Lafayette Ambassador Bank ................ 79,810 9.6 33,203 4.0 49,804 6.0 The Bank ................................. 71,506 10.1 28,292 4.0 42,437 6.0 Premier Bank ............................. 34,515 9.7 14,612 4.0 21,917 6.0 Tier I Capital (to Average Assets): Corporation .............................. $813,402 8.7% $279,600 3.0% $466,000 5.0% Fulton Bank .............................. 328,868 8.3 119,252 3.0 198,753 5.0 Lebanon Valley Farmers Bank .............. 55,142 6.9 24,058 3.0 40,096 5.0 Lafayette Ambassador Bank ................ 79,810 6.6 36,102 3.0 60,171 5.0 The Bank ................................. 71,506 6.9 30,931 3.0 51,551 5.0 Premier Bank ............................. 34,515 6.6 15,589 3.0 25,981 5.0
NOTE K - INCOME TAXES The components of the provision for income taxes are as follows:
Year ended December 31 --------------------------- 2004 2003 2002 ------- ------- ------- (in thousands) Current tax expense: Federal ............. $63,440 $53,342 $52,712 State ............... 417 1,277 1,764 ------- ------- ------- 63,857 54,619 54,476 Deferred tax expense ... 816 4,465 1,705 ------- ------- ------- $64,673 $59,084 $56,181 ======= ======= =======
54 The differences between the effective income tax rate and the Federal statutory income tax rate are as follows:
Year ended December 31 ---------------------- 2004 2003 2002 ---- ---- ---- Statutory tax rate ........................... 35.0% 35.0% 35.0% Effect of tax-exempt income .................. (2.9) (3.3) (3.3) Effect of low income housing investments ..... (2.1) (2.1) (2.1) State income taxes, net of Federal benefit ... 0.1 0.4 0.6 Other ........................................ (0.1) 0.2 (0.2) ---- ---- ---- Effective income tax rate .................... 30.2% 30.2% 30.0% ==== ==== ====
The net deferred tax asset recorded by the Corporation is included in other assets and consists of the following tax effects of temporary differences at December 31:
2004 2003 ------- ------- (in thousands) Deferred tax assets: Allowance for loan losses .................................... $31,370 $27,195 Deferred compensation ........................................ 6,072 3,776 Investments in low income housing ............................ 2,724 2,951 Post-retirement benefits ..................................... 3,403 3,318 Other accrued expenses ....................................... 1,549 1,406 Unrealized holding losses on securities available for sale ... 5,155 -- Other than temporary impairment of investments ............... 1,022 1,285 Stock-based compensation ..................................... 1,797 1,381 Other ........................................................ 1,541 767 ------- ------- Total gross deferred tax assets ........................... 54,633 42,079 ------- ------- Deferred tax liabilities: Direct leasing ............................................... 10,038 9,877 Unrealized holding gains on securities available for sale .... -- 6,620 Mortgage servicing rights .................................... 2,855 2,939 Premises and equipment ....................................... 2,003 1,304 Intangible assets ............................................ 5,014 2,723 Other ........................................................ 2,522 328 ------- ------- Total gross deferred tax liabilities ...................... 22,432 23,791 ------- ------- Net deferred tax asset .................................... $32,201 $18,288 ======= =======
The Corporation has net operating losses (NOL's) for income taxes in certain states that are eligible for carryforward credit against future taxable income for a specific number of years. The Corporation does not anticipate generating taxable income in these states during the carryforward years and, as such, deferred tax assets have not been recognized for these NOL's. As of December 31, 2004 and 2003, the Corporation had not established any valuation allowance against net Federal deferred tax assets since these tax benefits are realizable either through carryback availability against prior years' taxable income or the reversal of existing deferred tax liabilities. 55 NOTE L - EMPLOYEE BENEFIT PLANS Substantially all eligible employees of the Corporation are covered by one of the following plans or combination of plans: Profit Sharing Plan - A noncontributory defined contribution plan where employer contributions are based on a formula providing for an amount not to exceed 15% of each eligible employee's annual salary (10% for employees hired subsequent to January 1, 1996). Participants are 100% vested in balances after five years of eligible service. In addition, the profit sharing plan includes a 401(k) feature which allows employees to defer a portion of their pre-tax salary on an annual basis, with no employer match. Contributions under this feature are 100% vested. Defined Benefit Pension Plans and 401(k) Plans - Contributions to the Corporation's defined benefit pension plan (Pension Plan) are actuarially determined and funded annually. Pension Plan assets are invested in money markets, fixed income securities, including corporate bonds, U.S. Treasury securities and common trust funds, and equity securities, including common stocks and common stock mutual funds. The Pension Plan has been closed to new participants, but existing participants continue to accrue benefits according to the terms of the plan. Employees covered under the Pension Plan are also eligible to participate in the Fulton Financial Affiliates 401(k) Savings Plan, which allows employees to defer a portion of their pre-tax salary on an annual basis. At its discretion, the Corporation may also make a matching contribution up to 3%. Participants are 100% vested in the Corporation's matching contributions after three years of eligible service. The following summarizes the Corporation's expense under the above plans for the years ended December 31:
2004 2003 2002 ------- ------- ------ (in thousands) Profit Sharing Plan .... $ 8,251 $ 6,606 $6,220 Pension Plan ........... 3,072 3,025 1,812 401(k) Plan ............ 967 596 667 ------- ------- ------ $12,290 $10,227 $8,699 ======= ======= ======
The net periodic pension cost for the Corporation's Pension Plan, as determined by consulting actuaries, consisted of the following components for the years ended December 31:
2004 2003 2002 ------- ------- ------- (in thousands) Service cost ..................... $ 2,307 $ 2,178 $ 1,954 Interest cost .................... 3,102 2,952 2,653 Expected return on assets ........ (3,001) (2,631) (2,835) Net amortization and deferral .... 664 526 40 ------- ------- ------- Net periodic pension cost ........ $ 3,072 $ 3,025 $ 1,812 ======= ======= =======
56 The measurement date for the Pension Plan is September 30. The following table summarizes the changes in the projected benefit obligation and fair value of plan assets for the indicated periods:
Plan Year Ended September 30 ----------------- 2004 2003 ------- ------- (in thousands) Projected benefit obligation, beginning .. $52,282 $43,886 Service cost ............................. 2,307 2,178 Interest cost ............................ 3,102 2,952 Benefit payments ......................... (1,270) (1,666) Actuarial loss ........................... 2,552 5,309 Experience loss (gain) ................... 292 (377) ------- ------- Projected benefit obligation, ending ..... $59,265 $52,282 ======= ======= Fair value of plan assets, beginning ..... $37,980 $33,288 Employer contributions ................... 2,622 2,021 Actual return on assets .................. 2,136 4,337 Benefit payments ......................... (1,270) (1,666) ------- ------- Fair value of plan assets, ending ........ $41,468 $37,980 ======= =======
The funded status of the Pension Plan and the amounts included in other liabilities as of December 31 follows:
2004 2003 -------- -------- (in thousands) Projected benefit obligation .......... $(59,265) $(52,282) Fair value of plan assets ............. 41,468 37,980 -------- -------- Funded status ...................... (17,797) (14,302) Unrecognized net transition asset ..... (51) (64) Unrecognized prior service cost ....... 82 93 Unrecognized net loss ................. 15,687 12,645 Intangible asset ...................... (82) -- Accumulated other comprehensive loss .. (858) -- -------- -------- Pension liability recognized in the consolidated balance sheets ........ $ (3,019) $ (1,628) ======== ======== Accumulated benefit obligation ........ $ 44,487 $ 39,124 ======== ========
Accumulated other comprehensive income was reduced by $858,000 ($558,000, net of tax) as of December 31, 2004 to increase the pension liability to an amount equal to the difference between the accumulated benefit obligation and the fair value of plan assets. 57 The following rates were used to calculate net periodic pension cost and the present value of benefit obligations:
2004 2003 2002 ---- ---- ---- Discount rate-projected benefit obligation......... 5.75% 6.00% 6.75% Rate of increase in compensation level............. 4.50 4.50 5.00 Expected long-term rate of return on plan assets... 8.00 8.00 8.00
The 8.0% long-term rate of return on plan assets used to calculate the net periodic pension cost and present value of benefit obligations is based on historical returns. Although plan assets generated a negative return in 2002, total returns for 2004 and 2003 approximated this rate. The expected long-term return is considered to be appropriate based on the asset mix and the historical returns realized. The following table summarizes the weighted average asset allocations as of September 30:
2004 2003 ----- ----- Cash and equivalents...... 6.0% 9.0% Equity securities......... 50.0 51.0 Fixed income securities... 44.0 40.0 ----- ----- Total.................. 100.0% 100.0% ===== =====
Equity securities consist mainly of equity common trust and mutual funds. Fixed income securities consist mainly of fixed income common trust funds. Defined benefit plan assets are invested with a balanced growth objective, with target asset allocations between 40 and 70 percent for equity securities and 30 to 60 percent for fixed income securities. The Corporation expects to contribute $2.3 million to the pension plan in 2005. Estimated future benefit payments are as follows (in thousands):
Year ---- 2005.......... $ 1,217 2006.......... 1,370 2007.......... 1,411 2008.......... 1,583 2009.......... 1,761 2010 - 2014... 13,376 ------- $20,718 =======
Post-retirement Benefits The Corporation currently provides medical benefits and a death benefit to retired full-time employees who were employees of the Corporation prior to January 1, 1998. Full-time employees may become eligible for these discretionary benefits if they reach retirement while working for the Corporation. Benefits are based on a graduated scale for years of service after attaining the age of 40. The components of the expense for post-retirement benefits other than pensions are as follows:
2004 2003 2002 ----- ----- ----- (in thousands) Service cost....................... $ 364 $ 281 $ 260 Interest cost...................... 474 446 444 Expected return on plan assets..... (2) (2) (3) Net amortization and deferral...... (230) (287) (298) ----- ----- ----- Net post-retirement benefit cost... $ 606 $ 438 $ 403 ===== ===== =====
58 The following table summarizes the changes in the accumulated post-retirement benefit obligation and fair value of plan assets for the years ended December 31:
2004 2003 ------ ------ (in thousands) Accumulated post-retirement benefit obligation, beginning .. $7,815 $7,104 Service cost ............................................... 364 281 Interest cost .............................................. 474 446 Benefit payments ........................................... (268) (324) Change due to change in experience ......................... 296 (301) Change due to change in assumptions ........................ 248 609 ------ ------ Accumulated post-retirement benefit obligation, ending ..... $8,929 $7,815 ====== ====== Fair value of plan assets, beginning ....................... $ 165 $ 171 Employer contributions ..................................... 251 316 Actual return on assets .................................... 2 2 Benefit payments ........................................... (268) (324) ------ ------ Fair value of plan assets, ending .......................... $ 150 $ 165 ====== ======
The funded status of the plan and the amounts included in other liabilities as of December 31 follows:
2004 2003 ------- ------- (in thousands) Accumulated post-retirement benefit obligation .. $(8,929) $(7,815) Fair value of plan assets ....................... 150 165 Funded status ................................ (8,779) (7,650) ------- ------- Unrecognized prior service cost ................. (679) (905) Unrecognized net gain ........................... (39) (586) ------- ------- Post-retirement benefits liability recognized in the consolidated balance sheets ........... $(9,497) $(9,141) ======= =======
For measuring the post-retirement benefit obligation, the annual increase in the per capita cost of health care benefits was assumed to be 8.5% in year one, declining to an ultimate rate of 4.5% by year nine. This health care cost trend rate has a significant impact on the amounts reported. Assuming a 1.0% increase in the health care cost trend rate above the assumed annual increase, the accumulated post-retirement benefit obligation would increase by approximately $1.1 million and the current period expense would increase by approximately $123,000. Conversely, a 1% decrease in the health care cost trend rate would decrease the accumulated post-retirement benefit obligation by approximately $904,000 and the current period expense by approximately $100,000. The discount rate used in determining the accumulated post-retirement benefit obligation was 5.75% at December 31, 2004 and 6.00% at December 31, 2003. The expected long-term rate of return on plan assets was 3.00% at December 31, 2004 and 2003. In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (Medicare Bill) was signed into law. The Medicare Bill expands Medicare benefits, primarily by adding a prescription drug benefit for Medicare-eligible retirees beginning in 2006. The impact of this benefit on the Corporation's post-retirement benefit obligation was a reduction of $143,000 at December 31, 2004. 59 NOTE M - STOCK-BASED COMPENSATION PLANS AND SHAREHOLDERS' EQUITY Statement 123R requires that the fair value of equity awards to employees be recognized as compensation expense over the period during which an employee is required to provide service in exchange for such award. The Corporation adopted Statement 123R using "modified retrospective application", electing to restate all prior periods including all per share amounts. The principal accounts impacted by the restatement were salaries and employee benefits expense, additional paid-in capital, other assets and taxes. The Corporation's equity awards consist of stock options granted under its Stock Option and Compensation Plans (Option Plans) and shares purchased by employees under its Employee Stock Purchase Plan (ESPP). The following table summarizes the impact of modified retrospective application on the previously reported results for the periods shown:
2004 2003 2002 -------- -------- -------- (in thousands, except per-share data) Income before income taxes, originally reported ................................. $218,181 $197,543 $189,416 Stock-based compensation expense under the fair value method (2) .................... (3,900) (2,092) (2,281) -------- -------- -------- Income before income taxes, restated ........ $214,281 $195,451 $187,135 ======== ======== ======== Net income, originally reported ............. $152,917 $138,180 $132,948 Stock-based compensation expense under the fair value method, net of tax (2) ........ (3,309) (1,813) (1,994) -------- -------- -------- Net income, restated ........................ $149,608 $136,367 $130,954 ======== ======== ======== Net income per share (basic), originally reported (1) ............................. $ 1.02 $ 0.98 $ 0.94 Net income per share (basic), restated ...... 1.00 0.97 0.93 Net income per share (diluted), originally reported (1) ............................. $ 1.01 $ 0.98 $ 0.93 Net income per share (diluted), restated .... 0.99 0.96 0.92
(1) Originally reported amounts have been restated for the impact of the 5-for-4 stock split paid in June 2005. (2) Stock-based compensation expense, originally reported, was $0. The following table presents compensation expense and related tax benefits for equity awards recognized in the consolidated income statements:
2004 2003 2002 ------ ------ ------ (in thousands) Compensation expense .. $3,900 $2,092 $2,281 Tax benefit ........... (591) (279) (287) ------ ------ ------ Net income effect ..... $3,309 $1,813 $1,994 ====== ====== ======
The tax benefit shown in the preceding table is less than the benefit that would be calculated using the Corporation's 35% statutory Federal tax rate. Under Statement 123R, tax benefits are recognized upon grant only for options that ordinarily will result in a tax deduction when exercised ("non-qualified stock options"). The Corporation granted 607,000, 260,000 and 241,000 non-qualified stock options in 2004, 2003 and 2002, respectively. As a result of the retrospective adoption of Statement 123R, as of January 1, 2002 retained earnings decreased $9.4 million, additional paid in capital increased $10.3 million and deferred tax assets increased $887,000. These changes reflect a combination of compensation expense for prior stock option grants to employees and related tax benefits. 60 Under the Option Plan, options are granted to key personnel for terms of up to 10 years at option prices equal to the fair market value of the Corporation's stock on the date of grant. Options are typically granted annually on July 1st and are 100% vested immediately upon grant. As of December 30, 2004, the Option Plans had 16.0 million shares reserved for future grants through 2013. The following table provides information about options outstanding for the year ended December 31, 2004:
WEIGHTED AVERAGE AGGREGATE WEIGHTED REMAINING INTRINSIC STOCK AVERAGE CONTRACTUAL VALUE OPTIONS EXERCISE PRICE TERM (IN MILLIONS) ---------- -------------- ----------- ------------- Outstanding at December 31, 2003 .. 4,372,466 $10.58 Granted ........................ 1,304,814 16.15 Exercised ...................... (1,388,773) 6.72 Assumed from Resource .......... 1,176,504 4.87 Assumed from First Washington .. 1,129,222 6.30 Forfeited ...................... (3,180) 12.50 ---------- ------ Outstanding at December 31, 2004 .. 6,591,053 $10.74 6.1 years $52.1 ========== ====== ========= ===== Exercisable at December 31, 2004 .. 6,555,734 $10.77 6.1 years $51.6 ========== ====== ========= =====
The following table presents information about options exercised:
2004 2003 2002 ---------- -------- -------- (dollars in thousands) Number of options exercised..................... 1,388,773 532,181 492,809 Total intrinsic value of options exercised...... $ 13,577 $ 4,503 $ 3,216 Cash received from options exercised............ $ 6,341 $ 2,216 $ 2,769 Tax deduction realized from options exercised... $ 6,936 $ 1,960 $ 1,241
Upon exercise, the Corporation issues shares from its authorized, but unissued, common stock to satisfy the options. The fair value of option awards under the Option Plan is estimated on the date of grant using the Black-Scholes valuation methodology, which is dependent upon certain assumptions, as summarized in the following table.
2004 2003 2002 ------- ------- ------- Risk-free interest rate............. 4.22% 3.55% 4.78% Volatility of Corporation's stock... 18.12 22.75 23.64 Expected dividend yield............. 3.22 3.22 3.10 Expected life of options............ 7 YEARS 8 Years 8 Years
The expected life of the options was estimated based on historical employee behavior and represents the period of time that options granted are expected to be outstanding. Volatility of the Corporation's stock was based on historical volatility for the period commensurate with the expected life of the options. The risk-free interest rate is the U.S. Treasury rate commensurate with the expected life of the options on the date of the grant. Based on the assumptions used in the model, the Corporation calculated an estimated fair value per option of $2.78, $3.07 and $3.41 for options granted in 2004, 2003 and 2002, respectively. Approximately 1.3 million, 601,000 and 597,000 options were granted in 2004, 2003 and 2002, respectively. 61 Under the ESPP, eligible employees can purchase stock of the Corporation at 85% of the fair market value of the stock on the date of purchase. The ESPP is considered to be a compensatory plan under Statement 123R and, as such, compensation expense is recognized for the 15% discount on shares purchased. The following table summarizes activity under the ESPP for the indicated periods.
2004 2003 2002 ------- ------- ------- ESPP shares purchased............................ 105,392 108,380 120,496 Average purchase price (85% of market value)..... 14.55 12.82 11.42 Compensation expense recognized (in thousands)... 271 245 243
Shareholder Rights On June 20, 1989, the Board of Directors of the Corporation declared a dividend of one common share purchase right (Original Rights) for each outstanding share of common stock, par value $2.50 per share, of the Corporation. The dividend was paid to the shareholders of record as of the close of business on July 6, 1989. On April 27, 1999, the Board of Directors approved an amendment to the Original Rights and the rights agreement. The significant terms of the amendment included extending the expiration date from June 20, 1999 to April 27, 2009 and resetting the purchase price to $90.00 per share. As of December 31, 2004, the purchase price had adjusted to $43.08 per share as a result of stock dividends. The Rights are not exercisable or transferable apart from the common stock prior to distribution. Distribution of the Rights will occur ten business days following (1) a public announcement that a person or group of persons ("Acquiring Person") has acquired or obtained the right to acquire beneficial ownership of 20% or more of the outstanding shares of common stock (the "Stock Acquisition Date") or (2) the commencement of a tender offer or exchange offer that would result in a person or group beneficially owning 25% or more of such outstanding shares of common stock. The Rights are redeemable in full, but not in part, by the Corporation at any time until ten business days following the Stock Acquisition Date, at a price of $0.01 per Right. Treasury Stock The Corporation periodically repurchases shares of its common stock under repurchase plans approved by the Board of Directors. These repurchases have typically been through open market transactions and have complied with all regulatory restrictions on the timing and amount of such repurchases. Shares repurchased have been added to treasury stock and are accounted for at cost. These shares are periodically reissued for stock option exercises, ESPP purchases, acquisitions or other corporate needs. On November 19, 2004, the Corporation purchased 1.3 million shares of its common stock from an investment bank at a total cost of $22.0 million under an "Accelerated Share Repurchase" program (ASR), which allowed the shares to be purchased immediately rather than over time. The investment bank, in turn, is repurchasing shares on the open market over a period that is determined by the average daily trading volume of our shares, among other factors. The Corporation periodically settles its position with the investment bank by paying or receiving cash in an amount representing the difference between the initial price and the actual price of the shares repurchased. The Corporation expects the ASR to be completed during 2005. Total treasury stock purchases, including both open market purchases and the ASR, totaled approximately 4.7 million shares in 2004, 4.0 million shares in 2003 and 3.4 million shares in 2002. NOTE N - LEASES Certain branch offices and equipment are leased under agreements that expire at varying dates through 2025. Most leases contain renewal provisions at the Corporation's option. Total rental expense was approximately $9.4 million in 2004, $6.4 million in 2003 and $5.9 million in 2002. Future minimum payments as of December 31, 2004 under noncancelable operating leases are as follows (in thousands):
Year ---- 2005......... $ 8,051 2006......... 7,453 2007......... 6,508 2008......... 4,867 2009......... 3,725 Thereafter... 19,752 ------- $50,356 =======
62 NOTE O - COMMITMENTS AND CONTINGENCIES The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit and interest rate risk that are not recognized in the consolidated balance sheets. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments is expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income producing commercial properties. Standby letters of credit are conditional commitments issued to guarantee the financial or performance obligation of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation underwrites these obligations using the same criteria as its commercial lending underwriting. The Corporation's maximum exposure to loss for standby letters of credit is equal to the contractual (or notional) amount of the instruments. From time to time, the Corporation and its subsidiary banks may be defendants in legal proceedings relating to the conduct of their banking business. Most of such legal proceedings are a normal part of the banking business, and in management's opinion, the financial position and results of operations and cash flows of the Corporation would not be affected materially by the outcome of such legal proceedings. The following table presents the Corporation's commitments to extend credit and letters of credit:
2004 2003 ---------- ---------- (in thousands) Commercial mortgage, construction and land development .. $ 689,818 $ 297,156 Home equity ............................................. 412,790 333,139 Credit card ............................................. 384,504 314,532 Commercial and other .................................... 1,851,159 1,617,108 ---------- ---------- Total commitments to extend credit ................... $3,338,271 $2,561,935 ========== ========== Standby letters of credit ............................... $ 533,094 $ 483,522 Commercial letters of credit ............................ 24,312 16,992 ---------- ---------- Total letters of credit .............................. $ 557,406 $ 500,514 ========== ==========
64 NOTE P - FAIR VALUE OF FINANCIAL INSTRUMENTS The following are the estimated fair values of the Corporation's financial instruments as of December 31, 2004 and 2003, followed by a general description of the methods and assumptions used to estimate such fair values. These fair values are significantly affected by assumptions used, principally the timing of future cash flows and the discount rate. Because assumptions are inherently subjective in nature, the estimated fair values cannot be substantiated by comparison to independent market quotes and, in many cases, the estimated fair values could not necessarily be realized in an immediate sale or settlement of the instrument. Further, certain financial instruments and all non-financial instruments are excluded. Accordingly, the aggregate fair value amounts presented do not necessarily represent management's estimation of the underlying value of the Corporation.
2004 2003 ----------------------- ----------------------- ESTIMATED Estimated BOOK VALUE FAIR VALUE Book Value Fair Value ---------- ---------- ---------- ---------- (in thousands) FINANCIAL ASSETS Cash and due from banks ....... $ 278,065 $ 278,065 $ 300,966 $ 300,966 Interest-bearing deposits with other banks ........... 4,688 4,688 4,559 4,559 Federal funds sold ............ 32,000 32,000 -- -- Mortgage loans held for sale .. 158,872 158,872 32,761 32,761 Securities held to maturity ... 25,001 25,413 22,993 23,739 Securities available for sale . 2,424,858 2,424,858 2,904,157 2,904,157 Net loans ..................... 7,584,547 7,669,736 6,082,294 6,187,091 Accrued interest receivable ... 40,633 40,633 34,407 34,407 FINANCIAL LIABILITIES Demand and savings deposits ... $4,926,476 $4,926,476 $4,303,635 $4,303,635 Time deposits ................. 2,969,048 2,974,551 2,448,148 2,480,789 Short-term borrowings ......... 1,194,524 1,194,524 1,396,711 1,396,711 Accrued interest payable ...... 27,279 27,279 24,579 24,579 Other financial liabilities ... 29,640 29,640 26,769 26,769 Federal Home Loan Bank advances and long-term debt ......... 684,236 710,215 568,730 560,699
For short-term financial instruments, defined as those with remaining maturities of 90 days or less, the carrying amount was considered to be a reasonable estimate of fair value. The following instruments are predominantly short-term:
ASSETS LIABILITIES ------ ----------- Cash and due from banks Demand and savings deposits Interest bearing deposits Short-term borrowings Federal funds sold Accrued interest payable Accrued interest receivable Other financial liabilities Mortgage loans held for sale
For those components of the above-listed financial instruments with remaining maturities greater than 90 days, fair values were determined by discounting contractual cash flows using rates which could be earned for assets with similar remaining maturities and, in the case of liabilities, rates at which the liabilities with similar remaining maturities could be issued as of the balance sheet date. As indicated in Note A, "Summary of Significant Accounting Policies", securities available for sale are carried at their estimated fair values. The estimated fair values of securities held to maturity as of December 31, 2004 and 2003 were generally based on quoted market prices, broker quotes or dealer quotes. For short-term loans and variable rate loans that reprice within 90 days, the carrying value was considered to be a reasonable estimate of fair value. For other types of loans, fair value was estimated by discounting future cash flows using the current rates at which similar 65 loans would be made to borrowers with similar credit ratings and for the same remaining maturities. In addition, for loans secured by real estate, appraisal values for the collateral were considered in the fair value determination. The fair value of long-term debt was estimated by discounting the remaining contractual cash flows using a rate at which the Corporation could issue debt with a similar remaining maturity as of the balance sheet date. The fair value of commitments to extend credit and standby letters of credit is estimated to equal their carrying amounts. NOTE Q - MERGERS AND ACQUISITIONS Completed Acquisitions On December 31, 2004, the Corporation acquired all of the outstanding common stock of First Washington FinancialCorp (First Washington), of Windsor, New Jersey. First Washington was a $490 million bank holding company whose primary subsidiary was First Washington State Bank, which operates sixteen community-banking offices in Mercer, Monmouth, and Ocean Counties in New Jersey. This acquisition enabled the Corporation to expand and enhance its existing New Jersey franchise. The total purchase price was $125.8 million including $125.2 million in stock issued and options assumed and $610,000 in First Washington stock purchased for cash and other direct acquisition costs. The Corporation issued 1.69 shares of its stock for each of the 4.3 million shares of First Washington outstanding on the acquisition date. The purchase price was determined based on the value of the Corporation's stock on the date when the final terms of the acquisition were agreed to and announced. The acquisition was accounted for as a purchase and the Corporation's consolidated balance sheet includes First Washington balances as of December 31, 2004. Since this acquisition occurred on the last day of the year, the Corporation's results of operations do not include First Washington. The following is a summary of the preliminary purchase price allocation based on estimated fair values on the acquisition date (in thousands): Cash and due from banks.................... $ 14,823 Other earning assets ...................... 17,719 Investment securities available for sale... 206,068 Loans, net of allowance.................... 241,520 Premises and equipment .................... 12,110 Core deposit intangible asset.............. 6,685 Trade name intangible asset................ 417 Goodwill................................... 84,183 Other assets............................... 1,089 -------- Total assets acquired................... 584,614 -------- Deposits................................... 426,474 Short-term borrowings...................... 16,560 Long-term debt............................. 13,483 Other liabilities.......................... 2,262 -------- Total liabilities assumed............... 458,779 -------- Net assets acquired..................... $125,835 ========

In August 2004, the Corporation acquired Penn Business Credit, Inc. (PBC), a finance company with approximately $10.0 million of commercial loans located in Bala Cynwyd, PA. The Corporation paid approximately $6.1 million in cash and recorded $4.4 million in goodwill, representing the excess of the purchase price over the fair value of the net assets acquired. The goodwill recorded for this acquisition is being deducted for Federal income tax purposes on a straight-line basis over 15 years. PBC became a wholly owned subsidiary of Fulton Bank. On April 1, 2004, the Corporation acquired all of the outstanding common stock of Resource Bankshares Corporation (Resource), an $889 million financial holding company, and its primary subsidiary, Resource Bank. The total purchase price was $195.7 million, including $185.9 million in stock issued and options assumed, and $9.8 million in Resource stock purchased for cash and other direct 66 acquisition costs. The Corporation issued 1.93 shares of its stock for each of the 5.9 million shares of Resource outstanding on the acquisition date. The purchase price was determined based on the value of the Corporation's stock on the date when the final terms of the acquisition were agreed to and announced. Resource Bank is located in Virginia Beach, Virginia, and operates six community-banking offices in Newport News, Chesapeake, Herndon, Virginia Beach, and Richmond, Virginia and 14 loan production and residential mortgage offices in Virginia, North Carolina, Maryland and Florida. This acquisition allowed the Corporation to enter a new geographic market. The acquisition was accounted for as a purchase and the Corporation's results of operations include Resource from the date of acquisition. The following is a summary of the purchase price allocation based on estimated fair values on the acquisition date (in thousands): Cash and due from banks.................... $ 11,497 Other earning assets ...................... 5,222 Mortgage loans held for sale............... 94,546 Investment securities available for sale... 125,473 Loans, net of allowance.................... 619,118 Premises and equipment .................... 10,272 Core deposit intangible asset.............. 1,450 Trade name intangible asset................ 484 Goodwill................................... 146,062 Other assets............................... 28,690 ---------- Total assets acquired................... 1,042,814 ---------- Deposits................................... 598,389 Short-term borrowings...................... 111,195 Long-term debt............................. 120,532 Other liabilities.......................... 17,006 ---------- Total liabilities assumed............... 847,122 ---------- Net assets acquired..................... $ 195,692 ==========

On August 1, 2003, the Corporation acquired all of the outstanding common stock of Premier Bancorp, Inc. (Premier), a $600 million financial holding company, and its wholly-owned subsidiary, Premier Bank. The total purchase price was $92.0 million, including $2.1 million of direct acquisition costs. The Corporation issued 1.1846 shares of its stock for each of the 3.4 million shares of Premier outstanding on the acquisition date. The purchase price was determined based on the value of the Corporation's stock on the date when the final terms of the acquisition were agreed to and announced. Premier Bank is located in Doylestown, Pennsylvania and the eight community banking offices in Bucks, Northampton and Montgomery Counties, Pennsylvania acquired by the Corporation in this transaction complement its existing retail banking network. The acquisition was accounted for as a purchase and the Corporation's results of operations include Premier from the date of the acquisition. 67 The following table summarizes unaudited pro-forma information assuming the acquisitions of First Washington, Resource and Premier had occurred on January 1, 2003. This pro-forma information includes certain adjustments, including amortization related to fair value adjustments recorded in purchase accounting (in thousands, except per-share information):
2004 2003 -------- -------- Net interest income....... $381,251 $354,424 Other income.............. 147,764 163,352 Net income................ 156,069 152,038 Per Share: Net income (basic)..... $ 0.99 $ 0.96 Net income (diluted)... 0.98 0.95
Pending Acquisition On January 11, 2005, the Corporation entered into a merger agreement to acquire SVB Financial Services (SVB), of Somerville, New Jersey. SVB is a $475 million bank holding company whose primary subsidiary is Somerset Valley Bank, which operates eleven community-banking offices in Somerset, Hunterdon and Middlesex Counties in New Jersey. Under the terms of the merger agreement, each of the approximately 4.1 million shares of SVB's common stock will be acquired based on a "cash election merger" structure. Each SVB shareholder will have the ability to elect to receive 100% of the merger consideration in stock, 100% in cash, or a combination of FFC stock and cash. Their elections will be subject to prorating to achieve a result where a minimum of 20% and a maximum of 40% of SVB's outstanding shares will receive cash consideration. Those shares that will be converted into FFC stock would be exchanged based on a fixed exchange ratio of 1.1899 shares of FFC stock for each share of SVB stock. Those shares of SVB stock that will be converted into cash will be converted into a per share amount of cash based on a fixed price of $21.00 per share of SVB stock. In addition, each of the options to acquire SVB's stock will be converted to options to purchase the Corporation's stock. The acquisition is subject to approval by both the SVB shareholders and applicable bank regulatory authorities. The acquisition is expected to be completed during the third quarter of 2005. As a result of the acquisition, SVB will be merged into the Corporation and Somerset Valley Bank will become a wholly owned subsidiary. The acquisition will be accounted for as a purchase. Purchase accounting requires the Corporation to allocate the total purchase price of the acquisition to the assets acquired and liabilities assumed, based on their respective fair values at the acquisition date, with any remaining acquisition cost being recorded as goodwill. Resulting goodwill balances are then subject to an impairment review on at least an annual basis. The results of SVB's operations will be included in the Corporation's financial statements prospectively from the date of the acquisition. The total purchase price is estimated to be approximately $89.0 million, which includes cash paid, the value of the Corporation's stock to be issued, SVB's options to be converted and certain acquisition related costs. The net assets of SVB as of December 31, 2004 were $29.4 million and accordingly, the purchase price exceeds the carrying value of the net assets by $59.6 million as of this date. The total purchase price will be allocated to the net assets acquired as of the merger effective date, based on fair market values at that date. The Corporation expects to record a core deposit intangible asset and goodwill as a result of the acquisition accounting. 68 NOTE R - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY CONDENSED BALANCE SHEETS (in thousands)
December 31 ----------------------- 2004 2003 ---------- ---------- ASSETS Cash, securities, and other assets ................ $ 6,740 $ 9,567 Receivable from subsidiaries ....... 777 96 Investment in: Bank subsidiaries ............... 1,183,856 775,074 Non-bank subsidiaries ........... 250,901 235,431 ---------- ---------- Total Assets .................... $1,442,274 $1,020,168 ========== ========== LIABILITIES AND EQUITY Line of credit with bank subsidiaries ............... $ 70,500 $ 2,878 Revolving line of credit ........... 11,930 -- Long-term debt ..................... 34,955 34,717 Payable to non-bank subsidiaries ... 48,117 5,662 Other liabilities .................. 32,685 28,594 ---------- ---------- Total Liabilities ............... 198,187 71,851 Shareholders' equity ............... 1,244,087 948,317 ---------- ---------- Total Liabilities and Shareholders' Equity ......... $1,442,274 $1,020,168 ========== ==========
CONDENSED STATEMENTS OF INCOME
Year ended December 31 ------------------------------ 2004 2003 2002 -------- -------- -------- (in thousands) Income: Dividends from bank subsidiaries .............. $ 62,131 $149,596 $100,161 Other ......................................... 40,227 38,206 32,531 -------- -------- -------- 102,358 187,802 132,692 Expenses ......................................... 58,563 50,272 46,164 -------- -------- -------- Income before income taxes and equity in undistributed net income of subsidiaries ... 43,795 137,530 86,528 Income tax benefit ............................... (6,420) (4,177) (4,458) -------- -------- -------- 50,215 141,707 90,986 Equity in undistributed net income (loss) of: Bank subsidiaries ............................. 84,525 (20,879) 29,694 Non-bank subsidiaries ......................... 14,868 15,539 10,274 -------- -------- -------- Net Income ................................. $149,608 $136,367 $130,954 ======== ======== ========
69 CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31 ------------------------------- 2004 2003 2002 -------- --------- -------- (in thousands) Cash Flows From Operating Activities: Net Income ............................................. $149,608 $ 136,367 $130,954 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Stock-based compensation ............................... 3,900 2,092 2,281 (Increase) decrease in other assets .................... (13,004) 1,255 (2,357) (Increase) decrease in investment in subsidiaries ...... (99,393) 5,340 (39,968) Increase (decrease) in other liabilities and payable to non-bank subsidiaries .................... 36,859 (4,098) 5,249 -------- --------- -------- Total adjustments .................................. (71,638) 4,589 (34,795) -------- --------- -------- Net cash provided by operating activities ........... 77,970 140,956 96,159 Cash Flows From Investing Activities: Investment in bank subsidiaries ........................ (6,000) (3,500) (3,500) Net cash paid for acquisitions ......................... (5,283) (1,544) -- -------- --------- -------- Net cash used in investing activities ............... (11,283) (5,044) (3,500) Cash Flows From Financing Activities: Net increase (decrease) in borrowings .................. 79,552 (16,678) 9,056 Dividends paid ......................................... (74,802) (64,628) (58,954) Net proceeds from issuance of common stock ............. 7,537 5,087 3,267 Acquisition of treasury stock .......................... (78,966) (59,699) (46,133) -------- --------- -------- Net cash used in financing activities ............... (66,679) (135,918) (92,764) -------- --------- -------- Net Increase (Decrease) in Cash and Cash Equivalents ... 8 (6) (105) Cash and Cash Equivalents at Beginning of Year ......... -- 6 111 -------- --------- -------- Cash and Cash Equivalents at End of Year ............... $ 8 $ -- $ 6 ======== ========= ======== Cash paid during the year for: Interest ............................................ $ 2,889 $ 2,469 $ 1,791 Income taxes ........................................ 54,457 48,924 49,621
70 QUARTERLY CONSOLIDATED RESULTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER-SHARE DATA)
Three Months Ended ----------------------------------------- March 31 June 30 Sept. 30 Dec. 31 -------- -------- -------- -------- FOR THE YEAR 2004 Interest income ............. $113,936 $122,024 $126,947 $130,736 Interest expense ............ 30,969 33,318 34,446 37,261 -------- -------- -------- -------- Net interest income ......... 82,967 88,706 92,501 93,475 Provision for loan losses ... 1,740 800 1,125 1,052 Other income ................ 32,038 36,663 34,993 35,170 Other expenses .............. 62,344 70,598 74,036 70,537 -------- -------- -------- -------- Income before income taxes .. 50,921 53,971 52,333 57,056 Income taxes ................ 15,147 16,167 16,324 17,035 -------- -------- -------- -------- Net income .................. $ 35,774 $ 37,804 $ 36,009 $ 40,021 ======== ======== ======== ======== Per-share data: Net income (basic) ....... $ 0.25 $ 0.25 $ 0.24 $ 0.26 Net income (diluted) ..... 0.25 0.24 0.23 0.26 Cash dividends ........... 0.122 0.132 0.132 0.132 FOR THE YEAR 2003 Interest income ............. $110,184 $107,166 $105,907 $112,274 Interest expense ............ 34,546 32,796 32,128 31,624 -------- -------- -------- -------- Net interest income ......... 75,638 74,370 73,779 80,650 Provision for loan losses ... 2,835 2,490 2,190 2,190 Other income ................ 31,048 33,862 36,629 32,831 Other expenses .............. 55,330 57,452 60,579 60,290 -------- -------- -------- -------- Income before income taxes .. 48,521 48,290 47,639 51,001 Income taxes ................ 14,543 14,287 14,891 15,363 -------- -------- -------- -------- Net income .................. $ 33,978 $ 34,003 $ 32,748 $ 35,638 ======== ======== ======== ======== Per-share data: Net income (basic) ....... $ 0.24 $ 0.24 $ 0.24 $ 0.25 Net income (diluted) ..... 0.24 0.24 0.24 0.24 Cash dividends ........... 0.109 0.122 0.122 0.122
71 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Fulton Financial Corporation: We have audited management's assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, that Fulton Financial Corporation maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Fulton Financial Corporation's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that Fulton Financial Corporation maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Fulton Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Fulton Financial Corporation acquired First Washington Financial Corp. on December 31, 2004, and management excluded from its assessment of the effectiveness of Fulton Financial Corporation's internal control over financial reporting as of December 31, 2004, First Washington Financial Corp.'s internal control over financial reporting associated with total assets of approximately $585 million and total revenues of $0 included in the consolidated financial statements of Fulton Financial Corporation as of and for the year ended December 31, 2004. Our audit of internal control over financial reporting of Fulton Financial Corporation also excluded an evaluation of the internal control over financial reporting of First Washington Financial Corp. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Fulton Financial Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, shareholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated February 22, 2005 expressed an unqualified opinion on those consolidated financial statements. (signed) KPMG LLP Harrisburg, Pennsylvania February 22, 2005 72 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Fulton Financial Corporation: We have audited the accompanying consolidated balance sheets of Fulton Financial Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, shareholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fulton Financial Corporation and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. As discussed in note M to the financial statements, the Company changed its method of accounting for stock-based compensation plans in 2005, which was applied on a retrospective basis to prior periods. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Fulton Financial Corporation's internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 22, 2005 expressed an unqualified opinion on management's assessment of, and the effective operation of, internal control over financial reporting. (signed) KPMG LLP Harrisburg, Pennsylvania February 22, 2005, except as described in note M, which is as of November 9, 2005 73 EX-99.4 6 w15301exv99w4.txt ITEM 1 - FINANCIAL STATEMENTS (UNAUDITED - MARCH 31, 2005) . . . EXHIBIT 99.4 ITEM 1. FINANCIAL STATEMENTS (MARCH 31, 2005) FULTON FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEETS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
MARCH 31 December 31 2005 2004 ----------- ----------- ASSETS Cash and due from banks .............................. $ 336,039 $ 278,065 Interest-bearing deposits with other banks ........... 9,123 4,688 Federal funds sold ................................... 75,000 32,000 Mortgage loans held for sale ......................... 163,004 158,872 Investment securities: Held to maturity (estimated fair value of $27,807 in 2005 and $25,413 in 2004) ........... 27,570 25,001 Available for sale ................................ 2,357,788 2,424,858 Loans, net of unearned income ........................ 7,747,301 7,584,547 Less: Allowance for loan losses ................... (90,127) (89,627) ----------- ----------- Net Loans ...................................... 7,657,174 7,494,920 ----------- ----------- Premises and equipment ............................... 149,492 146,911 Accrued interest receivable .......................... 42,214 40,633 Goodwill ............................................. 364,169 364,019 Intangible assets .................................... 24,091 25,303 Other assets ......................................... 214,366 164,878 ----------- ----------- Total Assets ................................... $11,420,030 $11,160,148 =========== =========== LIABILITIES Deposits: Non-interest bearing .............................. $ 1,579,400 $ 1,507,799 Interest-bearing .................................. 6,401,747 6,387,725 ----------- ----------- Total Deposits ................................. 7,981,147 7,895,524 ----------- ----------- Short-term borrowings: Federal funds purchased ........................... 760,557 676,922 Other short-term borrowings ....................... 504,803 517,602 ----------- ----------- Total Short-Term Borrowings .................... 1,265,360 1,194,524 ----------- ----------- Accrued interest payable ............................. 29,546 27,279 Other liabilities .................................... 133,577 114,498 Federal Home Loan Bank advances and long-term debt ... 773,129 684,236 ----------- ----------- Total Liabilities .............................. 10,182,759 9,916,061 ----------- ----------- SHAREHOLDERS' EQUITY Common stock, $2.50 par value, 400 million shares authorized, 168.0 million shares issued in 2005 and 167.8 million shares issued in 2004 ... 336,022 335,604 Additional paid-in capital ........................... 1,017,549 1,018,403 Retained earnings .................................... 81,563 60,924 Accumulated other comprehensive loss ................. (35,698) (10,133) Treasury stock, 10.7 million shares in 2005 and 2004, at cost ................................. (162,165) (160,711) ----------- ----------- Total Shareholders' Equity ..................... 1,237,271 1,244,087 ----------- ----------- Total Liabilities and Shareholders' Equity ..... $11,420,030 $11,160,148 =========== ===========
See Notes to Consolidated Financial Statements 74 FULTON FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
THREE MONTHS ENDED MARCH 31 ------------------- 2005 2004 -------- -------- INTEREST INCOME Loans, including fees ...................... $116,628 $ 88,466 Investment securities: Taxable ................................. 18,261 21,736 Tax-exempt .............................. 2,849 2,533 Dividends ............................... 1,084 952 Mortgage loans held for sale ............... 1,812 239 Other interest income ...................... 176 10 -------- -------- Total Interest Income ................ 140,810 113,936 INTEREST EXPENSE Deposits ................................... 27,808 20,350 Short-term borrowings ...................... 6,824 3,327 Long-term debt ............................. 7,930 7,292 -------- -------- Total Interest Expense ............... 42,562 30,969 -------- -------- Net Interest Income .................. 98,248 82,967 PROVISION FOR LOAN LOSSES .................. 800 1,740 -------- -------- Net Interest Income After Provision for Loan Losses ......... 97,448 81,227 -------- -------- OTHER INCOME Investment management and trust services ... 9,019 8,645 Service charges on deposit accounts ........ 9,332 9,505 Other service charges and fees ............. 5,556 5,026 Gain on sale of mortgage loans ............. 6,049 1,714 Investment securities gains ................ 3,315 5,828 Other ...................................... 2,582 1,320 -------- -------- Total Other Income ................... 35,853 32,038 -------- -------- OTHER EXPENSES Salaries and employee benefits ............. 44,297 36,830 Net occupancy expense ...................... 7,498 5,518 Equipment expense .......................... 3,070 2,641 Data processing ............................ 3,169 2,819 Advertising ................................ 1,973 1,528 Intangible amortization .................... 1,179 991 Other ...................................... 12,641 12,017 -------- -------- Total Other Expenses ................. 73,827 62,344 -------- -------- Income Before Income Taxes ........... 59,474 50,921 INCOME TAXES ............................... 18,037 15,147 -------- -------- Net Income ........................... $ 41,437 $ 35,774 ======== ======== PER-SHARE DATA: Net income (basic) ......................... $ 0.26 $ 0.25 Net income (diluted) ....................... 0.26 0.25 Cash dividends ............................. 0.132 0.122
See Notes to Consolidated Financial Statements 75 FULTON FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED) THREE MONTHS ENDED MARCH 31, 2005 AND 2004
ACCUMULATED NUMBER OF ADDITIONAL OTHER SHARES COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY OUTSTANDING STOCK CAPITAL EARNINGS LOSS (INCOME) STOCK TOTAL ----------- -------- ---------- -------- ------------- --------- ---------- (dollars in thousands) Balance at December 31, 2004................ 157,150,000 $335,604 $1,018,403 $ 60,924 $(10,133) $(160,711) $1,244,087 Comprehensive income: Net income............................... 41,437 41,437 Unrealized loss on securities (net of $10.9 million tax effect).......... (20,170) (20,170) Unrealized loss on derivative financial instruments (net of $1.7 million tax effect)............................... (3,240) (3,240) Less - reclassification adjustment for gains included in net income (net of $1.2 million tax expense)............. (2,155) (2,155) ---------- Total comprehensive income............ 15,872 ---------- Stock issued, including related tax benefits (366,000 shares from treasury stock)..... 590,000 418 (950) 5,469 4,937 Stock-based compensation awards............. 96 96 Acquisition of treasury stock............... (400,000) (6,923) (6,923) Cash dividends - $0.132 per share........... (20,798) (20,798) ----------- -------- ---------- -------- -------- --------- ---------- Balance at March 31, 2005................... 157,340,000 $336,022 $1,017,549 $ 81,563 $(35,698) $(162,165) $1,237,271 =========== ======== ========== ======== ======== ========= ========== Balance at December 31, 2003................ 142,085,000 $284,480 $ 648,155 $104,187 $ 12,267 $(100,772) $ 948,317 Comprehensive Income: Net income............................... 35,774 35,774 Unrealized gain on securities (net of $4.3 million tax effect)...... 7,966 7,966 Less - reclassification adjustment for gains included in net income (net of $2.0 million tax expense)............. (3,788) (3,788) ---------- Total comprehensive income............ 39,952 ---------- Stock issued, including related tax benefits (all treasury stock)..................... 302,000 (2,083) 4,283 2,200 Stock-based compensation awards............. 72 72 Acquisition of treasury stock............... (214,000) (3,519) (3,519) Cash dividends - $0.122 per share........... (17,325) (17,325) ----------- -------- ---------- -------- -------- --------- ---------- Balance at March 31, 2004................... 142,173,000 $284,480 $ 646,144 $122,636 $ 16,445 $(100,008) $ 969,697 =========== ======== ========== ======== ======== ========= ==========
See Notes to Consolidated Financial Statements 76 FULTON FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
THREE MONTHS ENDED MARCH 31 --------------------- 2005 2004 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income ......................................................................... $ 41,437 $ 35,774 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses ....................................................... 800 1,740 Depreciation and amortization of premises and equipment ......................... 3,263 3,014 Net amortization of investment security premiums ................................ 1,256 2,569 Investment security gains ....................................................... (3,315) (5,828) Net (increase) decrease in mortgage loans held for sale ......................... (4,132) 3,943 Amortization of intangible assets ............................................... 1,179 991 Stock-based compensation ........................................................ 96 72 (Increase) decrease in accrued interest receivable .............................. (1,581) 1,579 Increase in other assets ........................................................ (5,031) (9,961) Increase in accrued interest payable ............................................ 2,267 332 Increase in other liabilities ................................................... 3,627 11,848 --------- --------- Total adjustments ............................................................ (1,571) 10,299 --------- --------- Net cash provided by operating activities .................................... 39,866 46,073 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of securities available for sale ............................... 56,380 68,197 Proceeds from maturities of securities held to maturity ............................ 1,525 2,814 Proceeds from maturities of securities available for sale .......................... 153,488 225,787 Purchase of securities held to maturity ............................................ (4,383) (2,084) Purchase of securities available for sale .......................................... (196,144) (73,835) (Increase) decrease in short-term investments ...................................... (47,435) 610 Net increase in loans .............................................................. (163,054) (58,252) Net cash paid for acquisitions ..................................................... -- (2,130) Net purchase of premises and equipment ............................................. (5,844) (2,609) --------- --------- Net cash (used in) provided by investing activities .......................... (205,467) 158,498 --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in demand and savings deposits ........................................ 48,989 65,810 Net increase (decrease) in time deposits ........................................... 36,634 (33,418) Increase in long-term debt ......................................................... 88,893 3,234 Increase (decrease) in short-term borrowings ....................................... 70,836 (214,238) Dividends paid ..................................................................... (19,795) (17,337) Net proceeds from issuance of common stock ......................................... 4,941 2,200 Acquisition of treasury stock ...................................................... (6,923) (3,519) --------- --------- Net cash provided by (used in) financing activities .......................... 223,575 (197,268) --------- --------- NET INCREASE IN CASH AND DUE FROM BANKS ............................................ 57,974 7,303 CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD ..................................... 278,065 300,966 --------- --------- CASH AND DUE FROM BANKS AT END OF PERIOD ........................................... $ 336,039 $ 308,269 ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the period for: Interest ........................................................................ $ 40,295 $ 30,637 Income taxes .................................................................... 799 104
See Notes to Consolidated Financial Statements 77 FULTON FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE A - BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. NOTE B - NET INCOME PER SHARE The Corporation's basic net income per share is calculated as net income divided by the weighted average number of shares outstanding. For diluted net income per share, net income is divided by the weighted average number of shares outstanding plus the incremental number of shares added as a result of converting common stock equivalents, calculated using the treasury stock method. The Corporation's common stock equivalents consist solely of outstanding stock options. A reconciliation of the weighted average shares outstanding used to calculate basic net income per share and diluted net income per share follows:
THREE MONTHS ENDED MARCH 31 ------------------ 2005 2004 ------- ------- (in thousands) Weighted average shares outstanding (basic)..... 157,351 142,114 Impact of common stock equivalents.............. 2,037 1,312 ------- ------- Weighted average shares outstanding (diluted)... 159,388 143,426 ======= =======
NOTE C - SUBSEQUENT EVENTS 5-for-4 Stock Split - The Corporation declared a 5-for-4 stock split on April 13, 2005. The stock split was paid in the form of a 25% stock dividend on June 8, 2005 to shareholders of record as of May 17, 2005. Share and per-share information presented in this report have been restated to reflect the impact of this stock split. Authorized Shares - On April 13, 2005, the shareholders of the Corporation approved an amendment to the Articles of Incorporation to increase the number of authorized shares of common stock from 400 million to 600 million shares. Branch Sales - On April 22, 2005 the Corporation sold two branches in New Jersey, including deposits totaling approximately $23.3 million. As a result of this transaction, a total gain of approximately $1.1 million will be recognized in the second quarter of 2005. The Corporation has entered into a contract for the sale of a branch in Maryland, including deposits totaling approximately $19.2 million at March 31, 2005. Per the terms of the contract, the deposits will be sold at a premium of 8% and the real property will be sold at net book value. This sale is expected to be completed during the second or third quarter of 2005, pending the receipt of certain regulatory approvals. 78 Accelerated Share Repurchase Plan - On May 4, 2005, the Corporation purchased 4.4 million shares of its common stock from an investment bank at a total cost of $73.6 million under an "Accelerated Share Repurchase" program (ASR), which allowed the shares to be repurchased immediately rather than over time. The investment bank, in turn, is repurchasing shares on the open market over a period that is determined by the average daily trading volume of our shares, among other factors. The Corporation expects to settle its position with the investment bank at the end of the ASR by paying or receiving cash in an amount representing the difference between the initial price and the actual price of the shares repurchased. The Corporation expects the ASR to be completed during 2005. NOTE D - DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION The Corporation does not have any operating segments, which require disclosure of additional information. While the Corporation owns thirteen separate banks, each engages in similar activities and provides similar products and services. The Corporation's non-banking activities are immaterial and therefore, separate information has not been disclosed. NOTE E - STOCK-BASED COMPENSATION Statement 123R requires that the fair value of equity awards to employees be recognized as compensation expense over the period during which an employee is required to provide service in exchange for such award. The Corporation adopted Statement 123R using "modified retrospective application", electing to restate all prior periods. The Corporation's equity awards consist of stock options granted under its Stock Option and Compensation Plans (Option Plans) and shares purchased by employees under its Employee Stock Purchase Plan (ESPP). The following table summarizes the impact of modified retrospective application on the three months ended March 31, 2004 (in thousands, except per-share data):
MAR. 31, 2004 -------- Income before income taxes, originally reported .......... $50,993 Stock-based compensation expense under the fair value method (2) ............................................ (72) ------- Income before income taxes, restated ..................... $50,921 ======= Net income, originally reported .......................... $35,846 Stock-based compensation expense under the fair value method, net of tax (2) ................................ (72) ------- Net income, restated ..................................... $35,774 ======= Net income per share (basic), originally reported (1) .... $ 0.25 Net income per share (basic), restated ................... 0.25 Net income per share (diluted), originally reported (1) .. $ 0.25 Net income per share (diluted), restated ................. 0.25
(1) Originally reported amounts have been restated for the impact of the 5-for-4 stock split paid in June 2005. (2) Stock-based compensation expense, originally reported, was $0. The following table presents compensation expense and related tax benefits for equity awards recognized in the consolidated income statements: 79
THREE MONTHS ENDED MARCH 31 --------------------------- 2005 2004 ---- ---- (in thousands) Compensation expense .. $96 $72 Tax benefit ........... (2) -- --- --- Net income effect ..... $94 $72 === ===
The tax benefit shown in the preceding table is less than the benefit that would be calculated using the Corporation's 35% statutory Federal tax rate as tax benefits are recognized upon grant only for equity awards that ordinarily will result in a tax deduction when exercised. As a result of the retrospective adoption of Statement 123R, as of December 31, 2003 retained earnings decreased $13.2 million, additional paid in capital increased $14.6 million and deferred tax assets increased $1.4 million. These changes reflect a combination of compensation expense for prior stock option grants to employees and related tax benefits. Under the Option Plan, options are granted to key personnel for terms of up to 10 years at option prices equal to the fair market value of the Corporation's stock on the date of grant. Options are typically granted annually on July 1st and are 100% vested immediately upon grant. As of March 31, 2005, the Option Plans had 16.0 million shares reserved for future grants through 2013. The following table provides information about options outstanding for the three months ended March 31, 2005:
WEIGHTED WEIGHTED AVERAGE AGGREGATE AVERAGE REMAINING INTRINSIC STOCK EXERCISE CONTRACTUAL VALUE OPTIONS PRICE TERM (IN MILLIONS) --------- -------- ----------- ------------- Outstanding at December 31, 2004... 6,591,053 $10.74 Granted......................... -- -- Exercised....................... (587,510) 6.18 Forfeited....................... (6,879) 15.54 --------- ------ Outstanding at March 31, 2005...... 5,996,664 $11.18 6.1 years $37.5 ========= ====== ========= ===== Exercisable at March 31, 2005...... 5,979,004 $11.20 6.1 years $37.3 ========= ====== ========= =====
The following table presents information about options exercised:
THREE MONTHS ENDED MARCH 31 --------------------------- 2005 2004 -------- -------- (dollars in thousands) Number of options exercised .................... 587,510 405,089 Total intrinsic value of options exercised ..... $ 6,770 $ 3,331 Cash received from options exercised ........... $ 3,012 $ 1,191 Tax deduction realized from options exercised .. $ 4,020 $ 2,049
Upon exercise, the Corporation issues shares from its authorized, but unissued, common stock to satisfy the options. 80 Under the ESPP, eligible employees can purchase stock of the Corporation at 85% of the fair market value of the stock on the date of purchase. The ESPP is considered to be a compensatory plan under Statement 123R and, as such, compensation expense is recognized for the 15% discount on shares purchased. The following table summarizes activity under the ESPP for the indicated periods.
THREE MONTHS ENDED MARCH 31 ------------------ 2005 2004 ------- ------- ESPP shares purchased............................ 36,558 27,490 Average purchase price (85% of market value)..... $ 14.93 $ 14.34 Compensation expense recognized (in thousands)... $ 96 $ 70
NOTE F - EMPLOYEE BENEFIT PLANS The Corporation maintains a defined benefit pension plan (Pension Plan) for certain employees. Contributions to the Pension Plan are actuarially determined and funded annually. Pension Plan assets are invested in money markets, fixed income securities, including corporate bonds, U.S. Treasury securities and common trust funds, and equity securities, including common stocks and common stock mutual funds. The Pension Plan has been closed to new participants, but existing participants continue to accrue benefits according to the terms of the plan. The Corporation expects to contribute approximately $2.3 million to the Pension Plan in 2005. The Corporation currently provides medical and life insurance benefits under a post-retirement benefits plan (Post-Retirement Plan) to certain retired full-time employees who were employees of the Corporation prior to January 1, 1998. Other certain full-time employees may become eligible for these discretionary benefits if they reach retirement age while working for the Corporation. Benefits are based on a graduated scale for years of service after attaining the age of 40. The net periodic benefit cost for the Corporation's Pension Plan and Post-Retirement Plan, as determined by consulting actuaries, consisted of the following components for the quarters ended March 31:
PENSION PLAN POST-RETIREMENT PLAN ------------- -------------------- 2005 2004 2005 2004 ----- ----- ---- ---- (in thousands) Service cost..................... $ 622 $ 577 $ 89 $ 91 Interest cost.................... 843 776 117 119 Expected return on plan assets... (818) (750) -- (1) Net amortization and deferral.... 222 166 (57) (58) ----- ----- ---- ---- Net periodic benefit cost........ $ 869 $ 769 $149 $151 ===== ===== ==== ====
NOTE G - NEW ACCOUNTING STANDARDS ACCOUNTING FOR CERTAIN LOANS OR DEBT SECURITIES ACQUIRED IN A TRANSFER: In December 2003, the Accounting Standards Executive Committee issued Statement of Position 03-3 (SOP 03-3), "Accounting for Certain Loans or Debt Securities Acquired in a Transfer". SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities acquired in a transfer, including business combinations, if those differences are attributable, at least in part, to credit quality. 81 SOP 03-3 became effective for the Corporation on January 1, 2005. No loans or debt securities meeting the scope of SOP 03-3 were acquired during the quarter ended March 31, 2005. The Corporation does not expect SOP 03-3 to have a material effect on the Corporation's consolidated financial statements in the future. OTHER THAN TEMPORARY IMPAIRMENT: In 2004, the Emerging Issues Task Force (EITF) released EITF Issue 03-01, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments" (EITF 03-01), which provides guidance for evaluating whether an investment is other-than-temporarily impaired and requires certain disclosures with respect to these investments. In September 2004, the FASB delayed the effective date of the measurement and recognition guidance of EITF 03-01 from the third calendar quarter of 2004 to a date to be determined upon the issuance of a final FASB Staff Position. The Corporation continues to apply the measurement and recognition criteria of existing authoritative literature in evaluating its investments for other than temporary impairment. Management does not expect EITF 03-01 to have a material impact on its financial condition or results of operations. NOTE H - ACQUISITIONS Completed Acquisitions On December 31, 2004, the Corporation acquired all of the outstanding common stock of First Washington FinancialCorp (First Washington), of Windsor, New Jersey. First Washington was a $490 million bank holding company whose primary subsidiary was First Washington State Bank, which operates sixteen community-banking offices in Mercer, Monmouth, and Ocean Counties in New Jersey. This acquisition enabled the Corporation to expand and enhance its existing New Jersey franchise. The total purchase price was $125.8 million including $125.2 million in stock issued and options assumed and $610,000 in First Washington stock purchased for cash and other direct acquisition costs. The Corporation issued 1.69 shares of its stock for each of the 4.3 million shares of First Washington outstanding on the acquisition date. The purchase price was determined based on the value of the Corporation's stock on the date when the final terms of the acquisition were agreed to and announced. On April 1, 2004, the Corporation acquired all of the outstanding common stock of Resource Bankshares Corporation (Resource), an $890 million financial holding company, and its primary subsidiary, Resource Bank. The total purchase price was $195.7 million, including $185.9 million in stock issued and options assumed, and $9.8 million in Resource stock purchased for cash and other direct acquisition costs. The Corporation issued 1.93 shares of its stock for each of the 5.9 million shares of Resource outstanding on the acquisition date. The purchase price was determined based on the value of the Corporation's stock on the date when the final terms of the acquisition were agreed to and announced. Resource Bank is located in Virginia Beach, Virginia, and operates six community-banking offices in Newport News, Chesapeake, Herndon, Virginia Beach, and Richmond, Virginia and fourteen loan production and residential mortgage offices in Virginia, North Carolina, Maryland and Florida. This acquisition allowed the Corporation to enter a new geographic market. The following table summarizes unaudited pro-forma information assuming the acquisitions of Resource and First Washington State Bank had occurred on January 1, 2004. This pro-forma information includes certain adjustments, including amortization related to fair value adjustments recorded in purchase accounting (in thousands, except per-share information): 82
THREE MONTHS ENDED MARCH 31, 2004 ------------------ Net interest income....... $94,082 Other income.............. 37,490 Net income................ 37,956 Per Share: Net income (basic)..... $ 0.24 Net income (diluted)... 0.24
Pending Acquisition On January 11, 2005, the Corporation entered into a merger agreement to acquire SVB Financial Services, Inc. (SVB), of Somerville, New Jersey. SVB is a $475 million bank holding company whose primary subsidiary is Somerset Valley Bank, which operates eleven community-banking offices in Somerset, Hunterdon and Middlesex Counties in New Jersey. Under the terms of the merger agreement, each of the approximately 4.1 million shares of SVB's common stock will be acquired based on a "cash election merger" structure. Each SVB shareholder will have the ability to elect to receive 100% of the merger consideration in stock, 100% in cash, or a combination of FFC stock and cash. Their elections will be subject to prorating to achieve a result where a minimum of 20% and a maximum of 40% of SVB's outstanding shares will receive cash consideration. Those shares that will be converted into FFC stock would be exchanged based on a fixed exchange ratio of 1.1899 shares of FFC stock for each share of SVB stock. Those shares of SVB stock that will be converted into cash will be converted into a per share amount of cash based on a fixed price of $21.00 per share of SVB stock. In addition, each of the options to acquire SVB's stock will be converted to options to purchase the Corporation's stock. The acquisition is subject to approval by both the SVB shareholders and applicable bank regulatory authorities. The acquisition is expected to be completed during the third quarter of 2005. As a result of the acquisition, SVB will be merged into the Corporation and Somerset Valley Bank will become a wholly owned subsidiary. The acquisition will be accounted for as a purchase. Purchase accounting requires the Corporation to allocate the total purchase price of the acquisition to the assets acquired and liabilities assumed, based on their respective fair values at the acquisition date, with any remaining acquisition cost being recorded as goodwill. Resulting goodwill balances are then subject to an impairment review on at least an annual basis. The results of SVB's operations will be included in the Corporation's financial statements prospectively from the date of the acquisition. The total purchase price is estimated to be approximately $87.7 million, which includes cash expected to be paid, the value of the Corporation's stock expected to be to be issued, SVB's options to be converted and certain acquisition related costs. The net assets of SVB as of March 31, 2005 were $30.5 million and, accordingly, the purchase price exceeds the carrying value of the net assets by $57.2 million as of this date. The total purchase price will be allocated to the net assets acquired as of the merger effective date, based on fair market values at that date. The Corporation expects to record a core deposit intangible asset and goodwill as a result of the acquisition accounting. NOTE I - DERIVATIVE FINANCIAL INSTRUMENTS - INTEREST RATE SWAPS As of March 31, 2005, interest rate swaps with a notional amount of $240 million were used to hedge certain long-term fixed rate certificate of deposit liabilities held at one of the Corporation's affiliate banks. The terms of the certificates of deposit and the interest rate swaps mirror each other and were committed to simultaneously. Under the terms of the swap agreements, the Corporation is the fixed rate receiver and the floating rate payer (generally tied to the three month London Interbank Offering Rate, or LIBOR, a common index used for setting rates between financial institutions). The combination of the interest rate swaps and the issuance of the certificates of deposit generates long- 83 term floating rate funding for the Corporation. The interest rate swaps are classified as a cash flow hedge and the fair values of the derivatives are recorded as other assets or other liabilities. Changes in the fair values during the period are recorded in other comprehensive income to the extent the hedge is effective. Ineffectiveness resulting from differences between the changes in fair value or cash flows of the certificate of deposits and the interest rate swaps must be recorded in current period earnings. The Corporation's analysis of the effectiveness of the hedges indicated they were 98.2% effective as of March 31, 2005. As a result, a $63,000 charge to income for the three-month period ended March 31, 2005 was recognized. During the first quarter of 2005, the Corporation recorded a $3.2 million other comprehensive loss to recognize the effective fair value changes of derivatives resulting from the rising interest rate environment. NOTE J - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Those financial instruments include commitments to extend credit and letters of credit, which involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Corporation's Consolidated Balance Sheets. Exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the outstanding amount of those instruments. The outstanding amounts of commitments to extend credit and letters of credit were as follows:
MARCH 31 --------------------- 2005 2004 --------- --------- (in thousands) ~~Commitments to extend credit... 3,492,011 2,688,675 Standby letters of credit...... 532,287 478,064 Commercial letters of credit... 24,654 20,266~~
NOTE K - SUBORDINATED DEBT On March 28, 2005 the Corporation issued $100.0 million of ten-year subordinated notes at a fixed rate of 5.35%, with semi annual interest payments commencing in October 2005. The notes mature on April 1, 2015. NOTE L - RECLASSIFICATIONS Certain amounts in the 2004 consolidated financial statements and notes have been reclassified to conform to the 2005 presentation. 84 EX-99.5 7 w15301exv99w5.txt ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MARCH 31, 2005) EXHIBIT 99.5 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MARCH 31, 2005) Management's Discussion and Analysis of Financial Condition and Results of Operations (Management's Discussion) concerns Fulton Financial Corporation (the Corporation), a financial holding company incorporated under the laws of the Commonwealth of Pennsylvania in 1982, and its wholly owned subsidiaries. This discussion and analysis should be read in conjunction with the consolidated financial statements and notes presented in this report. FORWARD-LOOKING STATEMENTS The Corporation has made, and may continue to make, certain forward-looking statements with respect to its acquisition and growth strategies, management of net interest income and margin, the ability to realize gains on equity investments, allowance and provision for loan losses, expected levels of certain non-interest expenses and the liquidity position of the Corporation and Parent Company. The Corporation cautions that these forward-looking statements are subject to various assumptions, risks and uncertainties. Because of the possibility of changes in these assumptions, risks and uncertainties, actual results could differ materially from forward-looking statements. In addition to the factors identified herein, the following could cause actual results to differ materially from such forward-looking statements: pricing pressures on loan and deposit products, actions of bank and non-bank competitors, changes in local and national economic conditions, changes in regulatory requirements, actions of the Federal Reserve Board (FRB), creditworthiness of current borrowers, customers' acceptance of the Corporation's products and services and acquisition pricing and the ability of the Corporation to continue making acquisitions. The Corporation's forward-looking statements are relevant only as of the date on which such statements are made. By making any forward-looking statements, the Corporation assumes no duty to update them to reflect new, changing or unanticipated events or circumstances. RESULTS OF OPERATIONS Overview As a financial institution with a focus on traditional banking activities, Fulton Financial Corporation generates the majority of its revenue through net interest income, or the difference between interest income earned on loans and investments and interest paid on deposits and borrowings. Growth in net interest income is dependent upon balance sheet growth and maintaining or increasing the net interest margin, which is net interest income as a percentage of average interest-earning assets. The Corporation also generates revenue through fees earned on the various services and products offered to its customers and through sales of assets, such as loans or investments. Offsetting these revenue sources are provisions for credit losses on loans, other operating expenses and income taxes. The Corporation's net income for the first quarter of 2005 increased $5.7 million, or 15.8%, from $35.8 million in 2004 to $41.4 million in 2005. Diluted net income per share increased $0.01, or 4.0%, from $0.25 in 2004 to $0.26 in 2005. The percentage increase in net income per share was lower than the net income increase as the average number of shares outstanding increased as a result of shares issued for acquisitions. The Corporation realized annualized returns on average assets of 1.50% and average equity of 13.43% during the first quarter of 2005. The annualized return on average tangible equity, which is net income, as adjusted for intangible amortization, net of tax, divided by average shareholders' equity, excluding goodwill and intangible assets, was 19.84% for the quarter. The Corporation adopted Statement of Financial Accounting Standards No. 123R, "Share-Based Payment" (Statement 123R) in the quarter ended September 30, 2005. Statement 123R requires that the fair value of equity awards to employees be recognized as compensation expense over the period during which an employee is required to provide 85 service in exchange for such award. The Corporation adopted Statement 123R using "modified retrospective application" and, therefore, all financial information in this report has been restated to reflect the impact of adoption. See Note E, "Stock-Based Compensation" in the Notes to Consolidated Financial Statements for information on the impact of adopting Statement 123R and its effect on prior periods. The increase in net income compared to the first quarter of 2004 resulted from an $15.3 million increase in net interest income, a $6.3 million increase in other income (excluding security gains) and a $940,000 decrease in the provision for loan losses, offset by a $2.5 million decrease in security gains, an $11.5 million increase in other expenses and a $2.9 million increase in income taxes. Net interest income growth resulted from increases in average earning assets, due to the acquisitions of Resource Bancshares Corporation (Resource) in April 2004 and First Washington FinancialCorp (First Washington) in December 2004 (see "Acquisitions" below). The net interest margin increased 4.2% compared to the first quarter of 2004, compounding the impact of the earning asset growth. The following summarizes some of the more significant factors that influenced the Corporation's first quarter 2005 results. Interest Rates - The FRB raised short-term interest rates seven times since March, 2004, resulting in a 175 basis point increase in both the Federal funds rate (from 1.00% to 2.75%) and the prime lending rate, (from 4.00% to 5.75%). These increases have had a positive impact on the Corporation's net interest margin and earnings as floating rate assets immediately adjusted to higher rates. The offsetting increase in rates on deposits and borrowings has not been as pronounced, however competitive pressure to reprice deposits has recently increased. Longer-term rates also increased over the past twelve months. The national monthly average of 30-year mortgage rates increased 42 basis points from 5.59% in 2004 to 6.01% in 2005. In a rising rate environment, the Corporation expects improvements in net interest income, as discussed in the "Market Risk" section of Management's Discussion. Continued increases in long-term rates, however, may have a detrimental impact on mortgage loan origination volumes and related gains on sales of mortgage loans. Earning Assets - The Corporation's interest-earning assets increased significantly, as a result of acquisitions and strong internal loan growth. This growth also contributed to the increase in net interest income. With improving regional economic conditions and with the slowdown of mortgage loan refinances, the Corporation is optimistic that internal loan growth in the short-term will continue to be positive. From 2004 to 2005, the Corporation experienced a shift in its composition of interest-earning assets from investments (23.8% of total average interest-earning assets in 2005, compared to 31.2% in 2004) to loans (74.8% in 2005 compared to 68.6% in 2004). This change resulted as funds from investment maturities, primarily mortgage-backed securities were reinvested in loans. The movement to higher-yielding loans has had a positive effect on the Corporation's net interest income and net interest margin. Asset Quality - Asset quality refers to the underlying credit characteristics of borrowers and the likelihood that defaults on contractual payments will result in charge-offs of account balances. Asset quality is generally a function of economic conditions, but can be managed through conservative underwriting and sound collection policies and procedures. The Corporation continued to maintain excellent asset quality, attributable to its credit culture and underwriting policies. Asset quality measures such as non-performing assets to total assets and net charge-offs to average loans improved in comparison to 2004, resulting in a lower provision for loan losses in the first quarter 2005. While overall asset quality has remained strong, deterioration in quality of one or several significant accounts could have a detrimental impact and result in losses that may not be foreseeable based on current information. In addition, rising interest rates could increase the total payments of borrowers and could have a negative impact on the ability of some to pay according to the terms of their loans. 86 Equity Markets - As noted in the "Market Risk" section of Management's Discussion, equity valuations can have an impact on the Corporation's financial performance. In particular, bank stocks account for a significant portion of the Corporation's equity investment portfolio. Gains on sales of these equities have been a recurring component of the Corporation's earnings for many years, including the first quarters of 2005 and 2004 with total gains of $2.5 million and $4.8 million, respectively. If this portfolio declines in value, this component of earnings could contract. Acquisitions - In April 2004, the Corporation acquired Resource, an $890 million financial holding company located in Virginia Beach, Virginia whose primary subsidiary was Resource Bank. This was the Corporation's first acquisition in Virginia, allowing it to enter a new geographic market. In December 2004, the Corporation acquired First Washington, a $490 million bank holding company located in Windsor, New Jersey whose primary subsidiary was First Washington State Bank. Results for 2005 in comparison to 2004 were impacted by these acquisitions (referred to collectively as the "Acquisitions"). On January 11, 2005, the Corporation entered into a merger agreement to acquire SVB Financial Services, Inc. (SVB) of Somerville, New Jersey. SVB is a $475 million bank holding company whose primary subsidiary is Somerset Valley Bank, which operates eleven community-banking offices in Somerset, Hunterdon and Middlesex counties in New Jersey. The acquisition is expected to be completed in the third quarter of 2005. For additional information on the terms of this pending acquisition, see Note H, "Acquisitions", in the Notes to Consolidated Financial Statements. Acquisitions have long been a supplement to the Corporation's internal growth. These recent and pending acquisitions provide the opportunity for additional growth as they will allow the Corporation's existing products and services to be sold in new markets. The Corporation's acquisition strategy focuses on high growth areas with strong market demographics and targets organizations that have a comparable corporate culture, strong performance and good asset quality, among other factors. Under its "super-community" banking philosophy, acquired organizations generally retain their status as separate legal entities, unless consolidation with an existing affiliate bank is practical. Back office functions are generally consolidated to maximize efficiencies. Merger and acquisition activity in the financial services industry has been very competitive in recent years, as evidenced by the prices paid for certain acquisitions. While the Corporation has been an active acquirer, management is committed to basing its pricing on rational economic models. Management will continue to focus on generating growth in the most cost-effective manner. Quarter ended March 31, 2005 versus quarter ended March 31, 2004 Net Interest Income Net interest income increased $15.3 million, to $98.2 million in 2005 from $83.0 million in 2004. This increase was due to both average balance growth, with total earning assets increasing 15.8%, and an improving net interest margin. The average yield on earning assets increased 49 basis points (a 9.7% increase) over 2004 while the cost of interest-bearing liabilities increased 38 basis points (a 22.5% increase). This resulted in a 16 basis point increase in net interest margin compared to the same period in 2004. The Corporation continues to manage its asset/liability position and interest rate risk through the methods discussed in the "Market Risk" section of Management's Discussion. 87 The following table provides a comparative average balance sheet and net interest income analysis for the first quarter of 2005 as compared to the same period in 2004 (dollars in thousands):
QUARTER ENDED MARCH 31, 2005 QUARTER ENDED MARCH 31, 2004 --------------------------------- -------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST RATE (1) BALANCE INTEREST RATE (1) ----------- -------- -------- ---------- -------- -------- ASSETS Interest-earning assets: Loans and leases .................. $ 7,675,034 $116,628 6.16% $6,187,988 $ 88,466 5.75% Taxable investment securities ..... 1,983,864 18,261 3.73 2,402,420 21,736 3.64 Tax-exempt investment securities .. 335,355 2,849 3.45 276,143 2,533 3.69 Equity securities ................. 123,800 1,084 3.55 131,553 952 2.91 ----------- -------- ---- ---------- -------- ---- Total investment securities .......... 2,443,019 22,194 3.68 2,810,116 25,221 3.61 Mortgage loans held for sale ...... 112,619 1,812 6.53 15,212 239 6.32 Other interest-earning assets ..... 28,699 176 2.49 3,741 10 1.08 ----------- -------- ---- ---------- -------- ---- Total interest-earning assets ........ 10,259,371 140,810 5.57% 9,017,057 113,936 5.08% Noninterest-earning assets: Cash and due from banks ........... 322,793 300,789 Premises and equipment ............ 149,017 121,428 Other assets ...................... 571,316 317,311 Less: Allowance for loan losses ... (90,489) (78,732) ----------- ---------- Total Assets ................... $11,212,008 $9,677,853 =========== ========== LIABILITIES AND EQUITY Interest-bearing liabilities: Demand deposits ................... $ 1,494,984 $ 2,970 0.81% $1,268,671 $ 1,355 0.43% Savings deposits .................. 1,911,820 4,466 0.95 1,760,104 2,507 0.57 Time deposits ..................... 2,996,377 20,372 2.76 2,431,742 16,488 2.73 ----------- -------- ---- ---------- -------- ---- Total interest-bearing deposits ...... 6,403,181 27,808 1.76 5,460,517 20,350 1.50 Short-term borrowings ............. 1,239,454 6,824 2.23 1,345,285 3,327 0.99 Long-term debt .................... 681,450 7,930 4.72 570,075 7,292 5.14 ----------- -------- ---- ---------- -------- ---- Total interest-bearing liabilities ... 8,324,085 42,562 2.07% 7,375,877 30,969 1.69% Noninterest-bearing liabilities: Demand deposits ................... 1,509,118 1,257,541 Other ............................. 127,148 93,352 ----------- ---------- Total Liabilities .............. 9,960,351 8,726,770 Shareholders' equity ................. 1,251,657 951,083 ----------- ---------- Total Liabilities and Shareholders' Equity ........ $11,212,008 $9,677,853 =========== ========== Net interest income .................. $ 98,248 $ 82,967 ======== ======== Net interest margin (FTE) ............ 3.95% 3.79% ==== ====
(1) Yields on tax-exempt securities are not fully taxable equivalent (FTE). 88 The following table summarizes the changes in interest income and expense due to changes in average balances (volume) and changes in rates:
2005 VS. 2004 INCREASE (DECREASE) DUE TO CHANGE IN -------------------------- VOLUME RATE NET ------- ------ ------- (in thousands) Interest income on: Loans and leases ........................ $21,684 $6,478 $28,162 Taxable investment securities ........... (3,997) 522 (3,475) Tax-exempt investment securities ........ 495 (179) 316 Equity securities ....................... (60) 192 132 Mortgage loans held for sale ............ 1,565 8 1,573 Other interest-earning assets ........... 139 27 166 ------- ------ ------- Total interest-earning assets ........ $19,826 $7,048 $26,874 ======= ====== ======= Interest expense on: Demand deposits ......................... $ 274 $1,341 $ 1,615 Savings deposits ........................ 228 1,731 1,959 Time deposits ........................... 3,706 178 3,884 Short-term borrowings ................... (281) 3,778 3,497 Long-term debt .......................... 1,289 (651) 638 ------- ------ ------- Total interest-bearing liabilities ... $ 5,216 $6,377 $11,593 ======= ====== =======
Interest income increased $26.9 million, or 23.6%, mainly as a result of the growth in average balances. Total interest-earning assets increased 13.8%, resulting in a $19.8 million increase in interest income. An additional $7.0 million increase was realized from the 49 basis point increase in rates. Average loans and leases increased $1.5 billion, or 24.0%. The following summarizes the growth in average loans by category:
THREE MONTHS ENDED MARCH 31 INCREASE (DECREASE) ----------------------- ------------------- 2005 2004 $ % ---------- ---------- ---------- ----- (dollars in thousands) Commercial - industrial and financial ..... $2,004,879 $1,606,165 $ 398,714 24.8% Commercial - agricultural ................. 326,699 349,198 (22,499) (6.4) Real estate - commercial mortgage ......... 2,439,800 2,013,488 426,312 21.2 Real estate - commercial construction ..... 362,953 253,824 109,129 43.0 Real estate - residential mortgage ........ 560,431 441,848 118,583 26.8 Real estate - residential construction .... 309,902 43,463 266,439 613.0 Real estate - home equity ................. 1,106,937 898,567 208,370 23.2 Consumer .................................. 500,465 512,947 (12,482) (2.4) Leasing and other ......................... 62,968 68,488 (5,520) (8.1) ---------- ---------- ---------- ----- Total .................................. $7,675,034 $6,187,988 $1,487,046 24.0% ========== ========== ========== =====
89 The Acquisitions contributed approximately $1.0 billion to the increase in average balances. The following table presents the average balance impact of the Acquisitions, by type:
THREE MONTHS ENDED MARCH 31 --------------------------- 2005 2004 ---------- ---- (in thousands) Commercial - industrial and financial ..... $ 212,101 $-- Commercial - agricultural ................. 1,604 -- Real estate - commercial mortgage ......... 275,022 -- Real estate - commercial construction ..... 103,562 -- Real estate - residential mortgage ........ 90,883 -- Real estate - residential construction .... 252,280 -- Real estate - home equity ................. 50,157 -- Consumer .................................. 6,287 -- Leasing and other ......................... 8,664 -- ---------- --- Total .................................. $1,000,560 $-- ========== ===
The following table presents the growth in average loans, by type, excluding the average balances contributed by the Acquisitions:
THREE MONTHS ENDED MARCH 31 INCREASE (DECREASE) --------------------------- ------------------- 2005 2004 $ % ---------- ---------- -------- ----- (dollars in thousands) Commercial - industrial and financial ..... $1,792,778 $1,606,165 $186,613 11.6% Commercial - agricultural ................. 325,095 349,198 (24,103) (6.9) Real estate - commercial mortgage ......... 2,164,778 2,013,488 151,290 7.5 Real estate - commercial construction ..... 259,391 253,824 5,567 2.2 Real estate - residential mortgage ........ 469,548 441,848 27,700 6.3 Real estate - residential construction .... 57,622 43,463 14,159 32.6 Real estate - home equity ................. 1,056,780 898,567 158,213 17.6 Consumer .................................. 494,178 512,947 (18,769) (3.7) Leasing and other ......................... 54,304 68,488 (14,184) (20.7) ---------- ---------- -------- ----- Total .................................. $6,674,474 $6,187,988 $486,486 7.9% ========== ========== ======== =====
Excluding the impact of the acquisitions, loan growth continued to be particularly strong in the commercial and commercial mortgage categories, which together increased $319.4 million, or 7.6%. Residential mortgage and residential construction increased $41.9 million, or 8.6%. Home equity loans increased $158.2 million, or 17.6%, due to promotional efforts and customers using home equity loans as a cost-effective refinance alternative. Consumer loans decreased slightly, reflecting repayment of these loans with tax-advantaged residential mortgage or home equity loans. Leasing and other loans decreased $14.2 million, or 20.7%. The average yield on loans during the first quarter of 2005 was 6.16%, a 41 basis point, or 7.1%, increase over 2004. This reflects the impact of a significant portfolio of floating rate loans, which immediately reprice to higher rates when interest rates rise, as they have over the past twelve months. Average investment securities decreased $367.1 million, or 13.1%. Excluding the impact of the Acquisitions, this decrease was $697.7 million, or 24.8%. During the past twelve months, the Corporation did not reinvest a significant portion of investment maturities in order to minimize interest rate risk in expectation of rising rates and to help fund loan growth. The average yield on investment securities increased 7 basis points from 3.61% in 2004 to 3.68% in 2005. 90 Interest expense increased $11.6 million, or 37.4%, to $42.6 million in the first quarter of 2005 from $31.0 million in the first quarter of 2004. Interest expense increased $5.2 million due to an increase in average balances, with the remaining $6.4 million increase resulting from the 38 basis point increase in the cost of total interest-bearing liabilities. The cost of interest-bearing deposits increased 26 basis points, or 17.3%, from 1.50% in 2004 to 1.76% in 2005. This increase was due to rising rates in general as a result of the FRB's rate increases over the past twelve months. The following table summarizes the growth in average deposits by category:
THREE MONTHS ENDED MARCH 31 INCREASE ----------------------- ----------------- 2005 2004 $ % ---------- ---------- ---------- ---- (dollars in thousands) Noninterest-bearing demand ... $1,509,118 $1,257,541 $ 251,577 20.0% Interest-bearing demand ...... 1,494,984 1,268,671 226,313 17.8 Savings/money market ......... 1,911,820 1,760,104 151,716 8.6 Time deposits ................ 2,996,377 2,431,742 564,635 23.2 ---------- ---------- ---------- ---- Total ..................... $7,912,299 $6,718,058 $1,194,241 17.8% ========== ========== ========== ====
The Acquisitions accounted for approximately $1.1 billion of the increase in average balances. The following table presents the average balance impact of the Acquisitions, by type:
THREE MONTHS ENDED MARCH 31 ------------------ 2005 2004 ---------- ---- (in thousands) Noninterest-bearing demand ... $ 116,911 $-- Interest-bearing demand ...... 110,971 -- Savings/money market ......... 117,488 -- Time deposits ................ 705,219 -- ---------- --- Total ..................... $1,050,589 $-- ========== ===
The following table presents the growth in average deposits, by type, excluding the contribution of the Acquisitions:
THREE MONTHS ENDED MARCH 31 INCREASE (DECREASE) ----------------------- ------------------- 2005 2004 $ % ---------- ---------- --------- ---- (dollars in thousands) Noninterest-bearing demand ... $1,392,207 $1,257,541 $ 134,666 10.7% Interest-bearing demand ...... 1,384,013 1,268,671 115,342 9.1 Savings/money market ......... 1,794,332 1,760,104 34,228 1.9 Time deposits ................ 2,291,158 2,431,742 (140,584) (5.8) ---------- ---------- --------- ---- Total ..................... $6,861,710 $6,718,058 $ 143,652 2.1% ========== ========== ========= ====
Average borrowings increased slightly from the first quarter of 2004. The Acquisitions added $227.1 million to short-term borrowings and $115.5 million to long-term debt. Excluding the Acquisitions, average short-term borrowings decreased $332.9 million, or 24.7%, to $1.0 billion in 2005, while average long-term debt 91 decreased $4.1 million or 0.7%, to $565.9 million. The decrease in short-term borrowings was mainly due to a decrease in Federal funds purchased which were reduced with funds from maturing securities. Provision and Allowance for Loan Losses The following table summarizes loans outstanding (net of unearned income) as of the dates shown:
MARCH 31 December 31 March 31 2005 2004 2004 ---------- ----------- ---------- (in thousands) Commercial - industrial and financial ... $1,975,981 $1,946,962 $1,621,583 Commercial - agricultural ............... 319,647 326,176 339,032 Real-estate - commercial mortgage ....... 2,540,554 2,461,016 2,042,234 Real-estate - commercial construction ... 366,624 348,846 250,214 Real-estate - residential mortgage ...... 556,966 543,072 436,043 Real-estate - residential construction .. 323,701 277,940 39,057 Real estate - home equity ............... 1,110,126 1,108,249 914,891 Consumer ................................ 496,031 506,290 508,518 Leasing and other ....................... 57,671 65,996 65,505 ---------- ---------- ---------- $7,747,301 $7,584,547 $6,217,077 ========== ========== ==========
The following table summarizes the activity in the Corporation's allowance for loan losses:
Three months ended March 31 ----------------------- 2005 2004 ---------- ---------- (dollars in thousands) Loans outstanding at end of period (net of unearned) .. $7,747,301 $6,217,077 ========== ========== Daily average balance of loans and leases ............. $7,675,034 $6,187,988 ========== ========== Balance at beginning of period ........................ $ 89,627 $ 77,700 Loans charged-off: Commercial, financial and agricultural ............. 822 979 Real estate - mortgage ............................. 187 765 Consumer ........................................... 766 787 Leasing and other .................................. 44 133 ---------- ---------- Total loans charged-off ............................ 1,819 2,664 ---------- ---------- Recoveries of loans previously charged-off: Commercial, financial and agricultural ............. 697 517 Real estate - mortgage ............................. 450 446 Consumer ........................................... 366 499 Leasing and other .................................. 6 33 ---------- ---------- Total recoveries ................................... 1,519 1,495 ---------- ---------- Net loans charged-off ................................. 300 1,169 Provision for loan losses ............................. 800 1,740 ---------- ---------- Balance at end of period .............................. $ 90,127 $ 78,271 ========== ========== Net charge-offs to average loans (annualized) ......... 0.02% 0.08% ========== ========== Allowance for loan losses to loans outstanding ........ 1.16% 1.26% ========== ==========
92 The following table summarizes the Corporation's non-performing assets as of the indicated dates:
MARCH 31 DECEMBER 31 MARCH 31 2005 2004 2004 -------- ----------- -------- (dollars in thousands) Non-accrual loans .................... $19,232 $22,574 $19,594 Loans 90 days past due and accruing .. 6,545 8,318 10,758 Other real estate owned (OREO) ....... 3,244 2,209 356 ------- ------- ------- Total non-performing assets .......... $29,021 $33,101 $30,708 ======= ======= ======= Non-accrual loans/Total loans ........ 0.25% 0.30% 0.32% Non-performing assets/Total assets ... 0.25% 0.30% 0.32% Allowance/Non-performing loans ....... 350% 290% 258%
The provision for loan losses for the first quarter of 2005 totaled $800,000, a decrease of $940,000, or 54.0%, from the same period in 2004. Net charge-offs totaled $300,000, or 0.02% of average loans on an annualized basis, during the first quarter of 2005, an $869,000 improvement over the $1.2 million, or 0.08%, in net charge-offs for the first quarter of 2004. Non-performing assets decreased to $29.0 million, or 0.25% of total assets, at March 31, 2005, from $30.7 million, or 0.32% of total assets, at March 31, 2004. Management believes that the allowance balance of $90.1 million at March 31, 2005 is sufficient to cover losses inherent in the loan portfolio on that date and is appropriate based on applicable accounting standards. Other Income The following table details the components of other income:
THREE MONTHS ENDED MARCH 31 INCREASE (DECREASE) ------------------ ------------------- 2005 2004 $ % ------- ------- ------- ----- (in thousands) Investment management and trust services .. $ 9,019 $ 8,645 $ 374 4.3% Service charges on deposit accounts ....... 9,332 9,505 (173) (1.8) Other service charges and fees ............ 5,556 5,026 530 10.5 Gain on sale of mortgage loans ............ 6,049 1,714 4,335 252.9 Investment securities gains ............... 3,315 5,828 (2,513) (43.1) Other ..................................... 2,582 1,320 1,262 95.6 ------- ------- ------- ----- Total .................................. $35,853 $32,038 $ 3,815 11.9% ======= ======= ======= =====
Total other income for the quarter ended March 31, 2005 was $35.9 million, an increase of $3.8 million, or 11.9%, over the comparable period in 2004. Excluding investment securities gains, which decreased from $5.8 million in 2004 to $3.3 million in 2005, other income increased $6.3 million, or 24.1%. The Acquisitions contributed $4.9 million to total other income in the first quarter of 2005. Gains on sale of mortgage loans increased $4.3 million with Resource Bank contributing $3.7 million of the increase. Service charges on deposit accounts decreased $173,000, or 1.8%, (excluding the Acquisitions, service charges on deposit accounts decreased $456,000). The decrease was mainly due to increases in existing customers' balances resulting in lower service charges for those accounts. Other income increased $1.3 million or 95.6%. The Acquisitions contributed $673,000 of the increase in other income with the remaining increase due to the change in the fair values of certain derivatives related to forward commitments for loan sales. 93 Investment securities gains decreased $2.5 million, or 43.1%. Investment securities gains during the first quarter of 2005 consisted of net realized gains of $2.5 million on the sale of equity securities and $790,000 on the sale of available for sale debt securities. Investment securities gains during the first quarter of 2004 consisted of net realized gains of $4.8 million on the sale of equity securities and $1.0 million on the sale of available for sale debt securities. Other Expenses The following table details the components of other expenses:
THREE MONTHS ENDED MARCH 31 INCREASE ------------------ -------------- 2005 2004 $ % ------- ------- ------- ---- (dollars in thousands) Salaries and employee benefits .. $44,297 $36,830 $ 7,467 20.3% Net occupancy expense ........... 7,498 5,518 1,980 35.9 Equipment expense ............... 3,070 2,641 429 16.2 Data processing ................. 3,169 2,819 350 12.4 Advertising ..................... 1,973 1,528 445 29.1 Intangible amortization ......... 1,179 991 188 19.0 Other ........................... 12,641 12,017 624 5.2 ------- ------- ------- ---- Total ........................ $73,827 $62,344 $11,483 18.4% ======= ======= ======= ====
Total other expenses increased $11.5 million, or 18.4%, in 2005, including $10.8 million due to the Acquisitions, detailed as follows:
THREE MONTHS ENDED MARCH 31 ------------------ 2005 2004 ------- ---- (in thousands) Salaries and employee benefits .. $ 5,893 $-- Net occupancy expense ........... 1,133 -- Equipment expense ............... 556 -- Data processing ................. 503 -- Advertising ..................... 220 -- Intangible amortization ......... 260 -- Other ........................... 2,233 -- ------- --- Total ........................ $10,798 $-- ======= ===
The following table presents the components of other expenses, excluding the amounts contributed by the Acquisitions, for the quarter ended March 31, 2005:
THREE MONTHS ENDED MARCH 31 INCREASE (DECREASE) ------------------ ------------------- 2005 2004 $ % ------- ------- ------- ----- (dollars in thousands) Salaries and employee benefits .. $38,404 $36,830 $ 1,574 4.3% Net occupancy expense ........... 6,365 5,518 847 15.3 Equipment expense ............... 2,514 2,641 (127) (4.8) Data processing ................. 2,666 2,819 (153) (5.4) Advertising ..................... 1,753 1,528 225 14.7 Intangible amortization ......... 919 991 (72) (7.3) Other ........................... 10,408 12,017 (1,609) (13.4) ------- ------- ------- ----- Total ........................ $63,029 $62,344 $ 685 1.1% ======= ======= ======= =====
The discussion that follows addresses changes in other expenses, excluding the Acquisitions. 94 Salaries and employee benefits increased $1.6 million, or 4.3%, in comparison to the first quarter of 2004. The salary expense component increased $1.0 million, or 3.5%, driven by salary increases for existing employees, as total average full-time equivalent employees remained relatively consistent at approximately 2,900. Employee benefits increased $533,000, or 7.8%, in comparison to the first quarter of 2004 driven mainly by continued increases in healthcare costs. Net occupancy expense increased $847,000, or 15.3%, to $6.4 million in 2005. The increase resulted from the expansion of the branch network and the addition of new office space for existing affiliates. Equipment expense decreased $127,000 or 4.8%, due to lower depreciation expense as certain equipment became fully depreciated. Data processing expense decreased $153,000, or 5.4%, mainly as a result of renegotiations of key processing contracts with certain vendors. Advertising expense increased $225,000, or 14.7%, due to normal retail promotional campaigns. Intangible amortization decreased $72,000, or 7.3%, in the first quarter of 2005. Intangible amortization consists of the amortization of unidentifiable intangible assets related to branch and loan acquisitions, core deposit intangible assets, and other identified intangible assets. Since many of these intangibles are amortized using accelerated methods, amortization expense of existing intangibles decreases over time. Other expense decreased $1.6 million, or 13.4%, mainly as a result of several non-recurring items, including a reduction of the reserve for legal contingencies and an adjustment in deferred origination costs. Income Taxes Income tax expense for the first quarter of 2005 was $18.0 million, a $2.9 million, or 19.1%, increase from $15.1 million in 2004. The Corporation's effective tax rate was approximately 30.3% in 2005 as compared to 29.7% in 2004. The effective rate is lower than the Federal statutory rate of 35% due mainly to investments in tax-free municipal securities and federal tax credits from investments in low and moderate income housing partnerships. FINANCIAL CONDITION Total assets of the Corporation increased $259.9 million, or 2.3%, to $11.4 billion at March 31, 2005, compared to $11.2 billion at December 31, 2004. Investment securities decreased $64.5 million, or 2.6%, as a result of investment maturities exceeding investment purchases, and a $25.1 million increase in unrealized losses due to rising interest rates. Loans outstanding, net of unearned income, increased $162.8 million, or 2.1%, during the period. Commercial loans, commercial mortgages, residential mortgages and home equity loans each increased slightly, offset by declines in consumer and leasing and other loans. Cash and due from banks increased $58.0 million, or 20.9%, to $336.0 million at March 31, 2005. Due to the nature of these accounts, daily balances can fluctuate up or down in the normal course of business. Other short-term investments, Federal funds sold and mortgage loans held for sale increased $51.6 million, or 26.4%, mainly due to a $43.0 million increase in Federal funds sold which was offset by an increase in Federal funds purchased. Other assets increased $49.5 million, or 30.0%, primarily due to an increase in receivables related to unsettled investment security sales. Deposits increased $85.6 million, or 1.1%, from December 31, 2004. Noninterest-bearing deposits increased $71.6 million, or 4.7%, while interest-bearing demand deposits decreased $22.4 million, or 1.5%, and savings deposits were unchanged. Time deposits increased $36.6 million reflecting a slight shift by customers to longer term investments as rates on time deposits have increased due to competitive pressures resulting from the FRB's two short-term interest rate increases during the first quarter of 2005. Short-term borrowings, which consist mainly of Federal funds purchased and customer cash management accounts, increased $70.8 million, or 5.9%, during the first quarter of 2005. This was mainly due to an 95 increase in Federal funds purchased. Long-term debt increased $88.9 million, or 13.0%, mainly due to $100.0 million of subordinated debt issued in March 2005. See the "Liquidity" section of Management's Discussion for a summary of the terms of this debt. Other liabilities increased $19.1 million, or 16.7%, due to a $6.7 million increase in accrued Federal income taxes and a $9.5 million increase in payables related to unsettled investment security purchases. Capital Resources Total shareholders' equity decreased $6.8 million, or 0.5%, during the first three months of 2005. Increases due to net income of $41.4 million and $4.9 million in stock issuances were offset by $22.3 million in unrealized losses on securities, $20.8 million in cash dividends to shareholders, $6.9 million in stock repurchases and $3.2 million in unrealized losses on derivative financial instruments. The Corporation periodically implements stock repurchase plans for various corporate purposes. In addition to evaluating the financial benefits of implementing repurchase plans, management also considers liquidity needs, the current market price per share and regulatory limitations. In 2002, the Board of Directors approved a stock repurchase plan, which was extended in both 2003 and 2004. On December 21, 2004 the Board of Directors approved an additional extension of the plan from December 31, 2004 to June 30, 2005 and increased the total number of shares that could be repurchased to 5.0 million. The plan originally permitted the Corporation to purchase 5.0 million shares. Prior to the date of the extension, there were only 1.9 million of the original 5.0 million shares still available to be repurchased. During the first quarter of 2005, 399,800 shares were purchased under this plan. As of March 31, 2005, there were approximately 4.6 million shares remaining that may be repurchased. The Corporation and its subsidiary banks are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain actions by regulators that could have a material effect on the Corporation's financial statements. The regulations require that banks maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk weighted assets (as defined), and Tier I capital to average assets (as defined). As of March 31, 2005, the Corporation and each of its bank subsidiaries met the minimum requirements. In addition, the Corporation and each of its bank subsidiaries' capital ratios exceeded the amounts required to be considered "well-capitalized" as defined in the regulations. The following table summarizes the Corporation's capital ratios in comparison to regulatory requirements as of March 31:
REGULATORY MINIMUM ---------------------- MARCH 31 DECEMBER 31 CAPITAL WELL 2005 2004 ADEQUACY CAPITALIZED -------- ----------- -------- ----------- Total Capital (to Risk Weighted Assets) ... 13.2% 11.8% 8.0% 10.0% Tier I Capital to (Risk Weighted Assets) .. 10.9% 10.6% 4.0% 6.0% Tier I Capital (to Average Assets) ........ 8.4% 8.8% 3.0% 5.0%
Liquidity The Corporation must maintain a sufficient level of liquid assets to meet the cash needs of its customers, who, as depositors, may want to withdraw funds or who, as borrowers, need credit availability. Liquidity is provided on a continuous basis through scheduled and unscheduled principal and interest payments on outstanding loans and investments and through the availability of deposits and borrowings. In addition, the Corporation can borrow on a secured basis from the Federal Home Loan Bank to meet short-term liquidity needs. The Corporation's sources and uses of cash were discussed in general terms in the net interest income section of Management's Discussion. The Consolidated Statements of Cash Flows provide additional information. The Corporation generated $39.9 million in cash from operating activities during the first quarter of 2005, mainly due to net income. Investing activities resulted in a net cash outflow of $205.5 96 million, as purchases of investment securities and loan originations exceeded sales and maturities of investment securities. Finally, financing activities resulted in a net inflow of $223.6 million due to increases in both deposits and borrowings. Liquidity must also be managed at the Fulton Financial Corporation Parent Company level. For safety and soundness reasons, banking regulations limit the amount of cash that can be transferred from subsidiary banks to the Parent Company in the form of loans and dividends. Generally, these limitations are based on the subsidiary banks' regulatory capital levels and their net income. Until 2004, the Parent Company had been able to meet its cash needs through normal, allowable dividends and loans. However, as a result of increased acquisition activity and stock repurchase plans, the Parent Company's cash needs have increased, requiring additional sources of funds. In July 2004, the Parent Company entered into a revolving line of credit agreement with an unaffiliated bank. Under the terms of the agreement, the Parent Company can borrow up to $50.0 million (may be increased to $100.0 million upon request) with interest calculated at the one-month London Interbank Offering Rate (LIBOR) plus 0.625%. The credit agreement requires the Corporation to maintain certain financial ratios related to capital strength and earnings. The Corporation was in compliance with all required covenants under the credit agreement as of March 31, 2005. As of March 31, 2005, there were no borrowings against this line. On March 28, 2005 the Corporation issued $100 million of ten-year subordinated notes at a fixed rate of 5.35%. See also Note K "Subordinated Debt " in the Notes to Consolidated Financial Statements. These borrowing arrangements supplement the liquidity available from subsidiaries through dividends and borrowings and provide some flexibility in Parent Company cash management. Management continues to monitor the liquidity and capital needs of the Parent Company and will implement appropriate strategies, as necessary, to remain well capitalized and to meet its cash needs. In addition to its normal recurring and operating cash needs, the Parent Company will also pay cash for a portion of the SVB acquisition, which is expected to be completed in the third quarter of 2005. Based on the terms of the merger agreement, the Parent Company will pay a minimum of approximately $17.0 million and a maximum of approximately $34.0 million to consummate the acquisition. See Note H, " Acquisitions" in the Notes to Consolidated Financial Statements for a summary of the terms of this transaction. 97 EX-99.6 8 w15301exv99w6.txt ITEM 1 - FINANCIAL STATEMENTS (UNAUDITED - JUNE 30, 2005) . . . EXHIBIT 99.6 ITEM 1. FINANCIAL STATEMENTS (JUNE 30, 2005) FULTON FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEETS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
JUNE 30 December 31 2005 2004 ----------- ----------- ASSETS Cash and due from banks ............................... $ 358,581 $ 278,065 Interest-bearing deposits with other banks ............ 21,842 4,688 Federal funds sold .................................... 758 32,000 Loans held for sale ................................... 237,713 158,872 Investment securities: Held to maturity (estimated fair value of $27,285 in 2005 and $25,413 in 2004) .................... 27,003 25,001 Available for sale ................................. 2,402,362 2,424,858 Loans, net of unearned income ......................... 7,861,508 7,584,547 Less: Allowance for loan losses .................... (90,402) (89,627) ----------- ----------- Net Loans ....................................... 7,771,106 7,494,920 ----------- ----------- Premises and equipment ................................ 153,598 146,911 Accrued interest receivable ........................... 43,819 40,633 Goodwill .............................................. 364,203 364,019 Intangible assets ..................................... 22,592 25,303 Other assets .......................................... 169,247 164,878 ----------- ----------- Total Assets .................................... $11,572,824 $11,160,148 =========== =========== LIABILITIES Deposits: Non-interest bearing ............................... $ 1,611,909 $ 1,507,799 Interest-bearing ................................... 6,527,758 6,387,725 ----------- ----------- Total Deposits .................................. 8,139,667 7,895,524 ----------- ----------- Short-term borrowings: Federal funds purchased ............................ 660,633 676,922 Other short-term borrowings ........................ 473,950 517,602 ----------- ----------- Total Short-Term Borrowings ..................... 1,134,583 1,194,524 ----------- ----------- Accrued interest payable .............................. 31,042 27,279 Other liabilities ..................................... 119,971 114,498 Federal Home Loan Bank advances and long-term debt .... 951,745 684,236 ----------- ----------- Total Liabilities ............................... 10,377,008 9,916,061 ----------- ----------- SHAREHOLDERS' EQUITY Common stock, $2.50 par value, 600 million shares authorized, 168.3 million shares issued in 2005 and 167.8 million shares issued in 2004 ............ 420,662 335,604 Additional paid-in capital ............................ 935,626 1,018,403 Retained earnings ..................................... 100,502 60,924 Accumulated other comprehensive loss .................. (20,166) (10,133) Treasury stock, 15.3 million shares in 2005 and 10.7 million shares in 2004, at cost ............... (240,808) (160,711) ----------- ----------- Total Shareholders' Equity ...................... 1,195,816 1,244,087 ----------- ----------- Total Liabilities and Shareholders' Equity ...... $11,572,824 $11,160,148 =========== ===========
See Notes to Consolidated Financial Statements 98 FULTON FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 ------------------- ------------------- 2005 2004 2005 2004 -------- -------- -------- -------- INTEREST INCOME Loans, including fees ..................... $123,309 $ 96,859 $239,937 $185,325 Investment securities: Taxable ................................ 18,257 19,652 36,518 41,388 Tax-exempt ............................. 2,843 2,540 5,692 5,073 Dividends .............................. 1,155 992 2,239 1,944 Mortgage loans held for sale .............. 2,699 1,962 4,511 2,201 Other interest income ..................... 348 19 524 29 -------- -------- -------- -------- Total Interest Income ............... 148,611 122,024 289,421 235,960 INTEREST EXPENSE Deposits .................................. 31,104 22,345 58,912 42,695 Short-term borrowings ..................... 7,914 3,135 14,738 6,462 Long-term debt ............................ 9,668 7,838 17,598 15,130 -------- -------- -------- -------- Total Interest Expense .............. 48,686 33,318 91,248 64,287 -------- -------- -------- -------- Net Interest Income ................. 99,925 88,706 198,173 171,673 PROVISION FOR LOAN LOSSES ................. 725 800 1,525 2,540 -------- -------- -------- -------- Net Interest Income After Provision for Loan Losses ........ 99,200 87,906 196,648 169,133 -------- -------- -------- -------- OTHER INCOME Investment management and trust services .. 8,966 8,637 17,985 17,282 Service charges on deposit accounts ....... 9,960 9,929 19,292 19,434 Other service charges and fees ............ 7,142 4,970 12,698 9,996 Gain on sale of mortgage loans ............ 6,290 6,050 12,339 7,764 Investment securities gains ............... 1,418 5,349 4,733 11,177 Other ..................................... 4,539 1,727 7,121 3,047 -------- -------- -------- -------- Total Other Income .................. 38,315 36,662 74,168 68,700 OTHER EXPENSES Salaries and employee benefits ............ 45,235 41,894 89,532 78,724 Net occupancy expense ..................... 6,549 5,859 14,047 11,377 Equipment expense ......................... 2,888 2,749 5,958 5,390 Data processing ........................... 3,321 2,868 6,490 5,687 Advertising ............................... 2,276 1,914 4,249 3,442 Intangible amortization ................... 1,168 1,356 2,347 2,347 Other ..................................... 16,752 13,957 29,393 25,974 -------- -------- -------- -------- Total Other Expenses ................ 78,189 70,597 152,016 132,941 -------- -------- -------- -------- Income Before Income Taxes .......... 59,326 53,971 118,800 104,892 INCOME TAXES .............................. 17,722 16,167 35,759 31,314 -------- -------- -------- -------- Net Income .......................... $ 41,604 $ 37,804 $ 83,041 $ 73,578 ======== ======== ======== ======== PER-SHARE DATA: Net income (basic) ........................ $ 0.27 $ 0.25 $ 0.53 $ 0.50 Net income (diluted) ...................... 0.27 0.24 0.53 0.49 Cash dividends ............................ 0.145 0.132 0.277 0.254
See Notes to Consolidated Financial Statements 99 FULTON FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED) SIX MONTHS ENDED JUNE 30, 2005 AND 2004
ACCUMULATED OTHER NUMBER OF ADDITIONAL COMPREHEN- SHARES COMMON PAID-IN RETAINED SIVE INCOME TREASURY OUTSTANDING STOCK CAPITAL EARNINGS (LOSS) STOCK TOTAL ----------- -------- ---------- -------- ----------- --------- ---------- (dollars in thousands) Balance at December 31, 2004................. 157,150,000 $335,604 $1,018,403 $ 60,924 $(10,133) $(160,711) $1,244,087 Comprehensive income: Net income............................. 83,041 83,041 Unrealized loss on derivative financial instruments (net of $540,000 tax effect)................ (1,003) (1,003) Unrealized loss on securities (net of $3.2 million tax effect)......... (5,954) (5,954) Less - reclassification adjustment for gains included in net income (net of $1.7 million tax expense)... (3,076) (3,076) ---------- Total comprehensive income....... 73,008 ---------- Stock split paid in the form of a 25% stock dividend............................ 84,046 (84,114) (68) Stock issued, including related tax benefits (340,000 shares from treasury stock)........................... 806,000 1,012 1,158 5,071 7,244 Stock-based compensation awards.............. 179 179 Acquisition of treasury stock................ (5,000,000) (85,168) (85,168) Cash dividends - $0.277 per share............ (43,463) (43,466) ----------- -------- ---------- -------- -------- --------- ---------- Balance at June 30, 2005..................... 152,956,000 $420,662 $ 935,626 $100,502 $(20,166) $(240,808) $1,195,816 =========== ======== ========== ======== ======== ========= ========== Balance at December 31, 2003................. 142,085,000 $284,480 $ 648,155 $104,187 $ 12,267 $(100,772) $ 948,317 Comprehensive income: Net income............................. 73,578 73,578 Unrealized loss on securities (net of $16.6 million tax effect)... (30,749) (30,749) Less - reclassification adjustment for gains included in net income (net of $3.9 million tax expense)... (7,265) (7,265) ---------- Total comprehensive income....... 35,564 ---------- Stock dividend - 5%.......................... 15,299 100,226 (115,615) (90) Stock issued, including related tax benefits (all treasury)................... 824,000 (6,302) 11,756 5,454 Stock-based compensation awards.............. 132 132 Stock issued for acquisition of Resource Bancshares Corporation.................... 11,287,000 21,498 164,365 185,863 Acquisition of treasury stock................ (1,845,000) (29,939) (29,939) Cash dividends - $0.254 per share............ (36,583) (36,583) ----------- -------- ---------- -------- -------- --------- ---------- Balance at June 30, 2004..................... 152,351,000 $321,277 $ 906,576 $ 25,567 $(25,747) $(118,955) $1,108,718 =========== ======== ========== ======== ======== ========= ==========
See Notes to Consolidated Financial Statements 100 FULTON FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
SIX MONTHS ENDED JUNE 30 ------------------------- 2005 2004 ------------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income .................................................. $ 83,041 $ 73,578 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses ................................ 1,525 2,540 Depreciation and amortization of premises and equipment .. 6,539 6,177 Net amortization of investment security premiums ......... 2,682 5,942 Investment securities gains .............................. (4,733) (11,177) Net increase in loans held for sale ...................... (58,455) (18,769) Amortization of intangible assets ........................ 2,347 2,347 Stock-based compensation ................................. 179 132 Increase in accrued interest receivable .................. (3,186) (1,294) (Increase) decrease in other assets ...................... (780) 6,006 Increase (decrease) in accrued interest payable .......... 3,763 (2,481) (Decrease) increase in other liabilities ................. (4,736) 5,643 --------- --------- Total adjustments ..................................... (54,855) (4,934) --------- --------- Net cash provided by operating activities ............. 28,186 68,644 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of securities available for sale ........ 101,196 179,971 Proceeds from maturities of securities held to maturity ..... 2,102 5,279 Proceeds from maturities of securities available for sale ... 311,054 457,086 Purchase of securities held to maturity ..................... (4,398) (3,699) Purchase of securities available for sale ................... (406,130) (133,005) Decrease in short-term investments .......................... 26,551 2,760 Net increase in loans ....................................... (298,097) (256,901) Net cash paid for acquisitions .............................. -- (768) Net purchase of premises and equipment ...................... (13,226) (5,966) --------- --------- Net cash (used in) provided by investing activities ... (280,948) 244,757 --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in demand and savings deposits ................. 122,355 203,212 Net increase (decrease) in time deposits .................... 121,788 (122,396) Increase (decrease) in long-term debt ....................... 267,509 (34,376) Decrease in short-term borrowings ........................... (59,941) (266,384) Dividends paid .............................................. (40,441) (34,762) Net proceeds from issuance of common stock .................. 7,176 5,454 Acquisition of treasury stock ............................... (85,168) (29,939) --------- --------- Net cash provided by (used in) financing activities ... 333,278 (279,191) --------- --------- NET INCREASE IN CASH AND DUE FROM BANKS ..................... 80,516 34,210 CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD .............. 278,065 300,966 --------- --------- CASH AND DUE FROM BANKS AT END OF PERIOD .................... $ 358,581 $ 335,176 ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the period for: Interest ................................................. $ 87,485 $ 66,768 Income taxes ............................................. 30,618 25,841
See Notes to Consolidated Financial Statements 101 FULTON FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE A - BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of Fulton Financial Corporation (the Corporation) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six-month periods ended June 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. NOTE B - NET INCOME PER SHARE AND COMPREHENSIVE INCOME (LOSS) The Corporation's basic net income per share is calculated as net income divided by the weighted average number of shares outstanding. For diluted net income per share, net income is divided by the weighted average number of shares outstanding plus the incremental number of shares added as a result of converting common stock equivalents, calculated using the treasury stock method. The Corporation's common stock equivalents consist solely of outstanding stock options. A reconciliation of the weighted average shares outstanding used to calculate basic net income per share and diluted net income per share follows:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 ------------------ ----------------- 2005 2004 2005 2004 ------- ------- ------- ------- Weighted average shares outstanding (basic) .... 154,509 152,647 155,922 147,380 Impact of common stock equivalents ............. 1,721 1,709 1,828 1,474 ------- ------- ------- ------- Weighted average shares outstanding (diluted) .. 156,230 154,356 157,750 148,854 ======= ======= ======= =======
Total comprehensive income was $57.1 million and $73.0 million for the three and six months ended June 30, 2005, respectively. Total comprehensive loss was $4.4 million for the quarter ended June 30, 2004 and total comprehensive income was $35.6 million for the six months ended June 30, 2004. NOTE C - 5-FOR-4 STOCK SPLIT The Corporation declared a 5-for-4 stock split on April 13, 2005, which was paid in the form of a 25% stock dividend on June 8, 2005 to shareholders of record on May 17, 2005. All share and per-share information has been restated to reflect the impact of this stock split. NOTE D - DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION The Corporation does not have any operating segments, which require disclosure of additional information. While the Corporation owned thirteen separate banks as of June 30, 2005, each engaged in similar activities and provided similar products and services. The Corporation's non-banking activities are immaterial and, therefore, separate information has not been disclosed. 102 NOTE E - STOCK-BASED COMPENSATION Statement 123R requires that the fair value of equity awards to employees be recognized as compensation expense over the period during which an employee is required to provide service in exchange for such award. The Corporation adopted Statement 123R using "modified retrospective application", electing to restate all prior periods. The Corporation's equity awards consist of stock options granted under its Stock Option and Compensation Plans (Option Plans) and shares purchased by employees under its Employee Stock Purchase Plan (ESPP). The following table summarizes the impact of modified retrospective application on the previously reported results for the periods shown:
SIX THREE MONTHS ENDED MONTHS ------------------- ENDED MAR. 31, JUNE 30, JUNE 30, 2005 2004 2004 -------- -------- -------- (in thousands, except per-share data) Income before income taxes, originally reported .......... $59,570 $54,031 $105,024 Stock-based compensation expense under the fair value method (2) ............................................ (96) (60) (132) ------- ------- -------- Income before income taxes, restated ..................... $59,474 $53,971 $104,892 ======= ======= ======== Net income, originally reported .......................... $41,531 $37,864 $ 73,710 Stock-based compensation expense under the fair value method, net of tax (2) ................................ (94) (60) (132) ------- ------- -------- Net income, restated ..................................... $41,437 $37,804 $ 73,578 ======= ======= ======== Net income per share (basic), originally reported (1) .... $ 0.26 $ 0.25 $ 0.50 Net income per share (basic), restated ................... 0.26 0.25 0.50 Net income per share (diluted), originally reported (1) .. $ 0.26 $ 0.25 $ 0.49 Net income per share (diluted), restated ................. 0.26 0.24 0.49
(1) Originally reported amounts have been restated for the impact of the 5-for-4 stock split paid in June 2005. (2) Stock-based compensation expense, originally reported, was $0. The following table presents compensation expense and related tax benefits for equity awards recognized in the consolidated income statements:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 ------------------ ---------------- 2005 2004 2005 2004 ----- ---- ----- ---- (in thousands) Compensation expense .......................... $ 83 $60 $ 179 $132 Tax benefit ................................... (107) -- (109) -- ----- --- ----- ---- Net income (increase) decrease ................ $ (24) $60 $ 70 $132 ===== === ===== ====
As a result of the retrospective adoption of Statement 123R, as of December 31, 2003 retained earnings decreased $13.2 million, additional paid in capital increased $14.6 million and deferred tax assets increased $1.4 million. These changes reflect a combination of compensation expense for prior stock option grants to employees and related tax benefits. The tax benefits shown in the preceding table differs from the benefit that would be calculated using the Corporation's 35% statutory Federal tax rate as tax benefits are recognized upon grant only for equity awards that ordinarily will result in a tax 103 deduction when exercised. Tax benefits for other equity awards are recognized when realized, generally when exercised in a manner resulting in a tax deduction for the corporation. Under the Option Plans, options are granted to key personnel for terms of up to 10 years at option prices equal to the fair market value of the Corporation's stock on the date of grant. Options are typically granted annually on July 1st and, prior to the July 1, 2005 grant, had been 100% vested immediately upon grant. For the July 1, 2005 grant, a three-year cliff vesting feature was added and, as a result, compensation expense associated with this grant will be recognized over the three year vesting period. Certain events as defined in the Option Plans, including a change of control, would result in the acceleration of the vesting. As of June 30, 2005, the Option Plans had 16.0 million shares reserved for future grants through 2013. The following table provides information about options outstanding for the six months ended June 30, 2005:
WEIGHTED WEIGHTED AVERAGE AGGREGATE AVERAGE REMAINING INTRINSIC STOCK EXERCISE CONTRACTUAL VALUE OPTIONS PRICE TERM (IN MILLIONS) --------- -------- ----------- ------------- Outstanding at December 31, 2004 ... 6,591,053 $10.74 Granted ......................... -- -- Exercised ....................... (804,031) 6.93 Forfeited ....................... (10,314) 15.51 --------- ------ Outstanding at June 30, 2005 ....... 5,776,708 $11.27 5.9 years $38.9 ========= ====== ========= ===== Exercisable at June 30, 2005 ....... 5,759,048 $11.28 5.9 years $38.7 ========= ====== ========= =====
The following table presents information about options exercised:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 ------------------- ------------------- 2005 2004 2005 2004 -------- -------- -------- -------- (dollars in thousands) Number of options exercised.......................... 216,521 523,199 804,031 928,288 Total intrinsic value of options exercised........... $ 1,829 $ 5,555 $ 8,599 $ 8,886 Cash received from options exercised................. $ 1,548 $ 2,473 $ 4,560 $ 3,664 Tax deduction realized from options exercised........ $ 1,298 $ 1,614 $ 5,318 $ 3,663
Upon exercise, the Corporation issues shares from its authorized, but unissued, common stock to satisfy the options. Under the ESPP, eligible employees can purchase stock of the Corporation at 85% of the fair market value of the stock on the date of purchase. The ESPP is considered to be a compensatory plan under Statement 123R and, as such, compensation expense is recognized for the 15% discount on shares purchased. The following table summarizes activity under the ESPP for the indicated periods. 104
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 ------------------ ----------------- 2005 2004 2005 2004 ------- ------- ------- ------- ESPP shares purchased................................ 31,921 25,266 68,479 52,756 Average purchase price (85% of market value)......... $ 14.80 $ 13.90 $ 14.87 $ 14.13 Compensation expense recognized (in thousands)....... $ 83 $ 62 $ 180 $ 132
NOTE F - EMPLOYEE BENEFIT PLANS The Corporation maintains a defined benefit pension plan (Pension Plan) for certain employees. Contributions to the Pension Plan are actuarially determined and funded annually. Pension Plan assets are invested in money markets, fixed income securities, including corporate bonds, U.S. Treasury securities and common trust funds, and equity securities, including common stocks and common stock mutual funds. The Pension Plan has been closed to new participants, but existing participants continue to accrue benefits according to the terms of the plan. The Corporation expects to contribute approximately $2.3 million to the Pension Plan in 2005. The Corporation currently provides medical and life insurance benefits under a post-retirement benefits plan (Post-Retirement Plan) to certain retired full-time employees who were employees of the Corporation prior to January 1, 1998. Other certain full-time employees may become eligible for these discretionary benefits if they reach retirement age while working for the Corporation. Benefits are based on a graduated scale for years of service after attaining the age of 40. The net periodic benefit cost for the Corporation's Pension Plan and Post-Retirement Plan, as determined by consulting actuaries, consisted of the following components for the three and six-month periods ended June 30:
PENSION PLAN -------------------------------------- THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 ------------------ ----------------- 2005 2004 2005 2004 ----- ----- ------- ------- (in thousands) Service cost.......................... $ 621 $ 577 $ 1,245 $ 1,154 Interest cost......................... 842 776 1,685 1,551 Expected return on plan assets........ (819) (750) (1,637) (1,500) Net amortization and deferral......... 221 166 443 332 ----- ----- ------- ------- Net periodic benefit cost............. $ 865 $ 769 $ 1,736 $ 1,537 ===== ===== ======= =======

POST-RETIREMENT PLAN -------------------------------------- THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 ------------------ ----------------- 2005 2004 2005 2004 ---- ---- ----- ----- (in thousands) Service cost ......................... $ 88 $ 91 $ 177 $ 182 Interest cost ........................ 114 118 231 237 Expected return on plan assets ....... (1) -- (1) (1) Net amortization and deferral ........ (55) (57) (112) (115) ---- ---- ----- ----- Net periodic benefit cost ............ $146 $152 $ 295 $ 303 ==== ==== ===== =====
NOTE G - NEW ACCOUNTING STANDARDS ACCOUNTING FOR CERTAIN LOANS OR DEBT SECURITIES ACQUIRED IN A TRANSFER: In December 2003, the Accounting Standards Executive Committee issued Statement of Position 03-3 (SOP 03-3), "Accounting for Certain Loans or Debt Securities Acquired in a Transfer". SOP 03-3 addresses accounting for differences between contractual cash flows and 105 cash flows expected to be collected from an investor's initial investment in loans or debt securities acquired in a transfer, including business combinations, if those differences are attributable, at least in part, to credit quality. SOP 03-3 became effective for the Corporation on January 1, 2005. No loans or debt securities meeting the scope of SOP 03-3 were acquired during the three or six-month periods ended June 30, 2005. The Corporation does not expect SOP 03-3 to have a material effect on the Corporation's consolidated financial statements in the future. OTHER THAN TEMPORARY IMPAIRMENT: In 2004, the Emerging Issues Task Force released Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments" (EITF 03-1), which provides guidance for evaluating whether an investment is other-than-temporarily impaired and requires certain disclosures with respect to these investments. In June 2005, the FASB voted to nullify certain provisions of EITF 03-1 which addressed the evaluation of an impairment to determine whether it was other-than-temporary. In general, these provisions required companies to declare their ability and intent to hold other-than-temporarily impaired investments until they recovered their losses. If a company was unable to make this declaration, write-downs of investment securities through losses charged to the income statement would be required. The effective date of these provisions was originally delayed in September 2004, due to industry concerns about the potential impact of this proposed accounting. Adoption of the surviving provisions of EITF 03-1 did not have a material impact on the Corporation's financial condition or results of operations. The Corporation continues to apply the provisions of existing authoritative literature in evaluating its investments for other-than-temporary impairment. NOTE H - ACQUISITIONS On December 31, 2004, the Corporation acquired all of the outstanding common stock of First Washington FinancialCorp (First Washington), of Windsor, New Jersey. First Washington was a $490 million bank holding company whose primary subsidiary was First Washington State Bank (FWSB), which operates sixteen community-banking offices in Mercer, Monmouth and Ocean Counties in New Jersey. This acquisition enabled the Corporation to expand and enhance its existing New Jersey franchise. The total purchase price was $125.8 million, including $125.2 million in stock issued and stock options assumed and $610,000 in First Washington stock purchased for cash and other direct acquisition costs. The Corporation issued 1.69 shares of its stock for each of the 4.3 million shares of First Washington outstanding on the acquisition date. The purchase price was determined based on the value of the Corporation's stock on the date when the final terms of the acquisition were agreed to and announced. On April 1, 2004, the Corporation acquired all of the outstanding common stock of Resource Bankshares Corporation (Resource), an $890 million financial holding company, and its primary subsidiary, Resource Bank. Resource Bank is located in Virginia Beach, Virginia, and operates six community-banking offices in Newport News, Chesapeake, Herndon, Virginia Beach and Richmond, Virginia and fourteen loan production and residential mortgage offices in Virginia, North Carolina, Maryland and Florida. This acquisition allowed the Corporation to enter a new geographic market. The total purchase price was $195.7 million, including $185.9 million in stock issued and stock options assumed and $9.8 million in Resource stock purchased for cash and other direct acquisition costs. The Corporation issued 1.925 shares of its stock for each of the 5.9 million shares of Resource outstanding on the acquisition date. The purchase price was determined based on the value of the Corporation's stock on the date when the final terms of the acquisition were agreed to and announced. The following table summarizes unaudited pro-forma information assuming the acquisitions of Resource and First Washington had occurred on January 1, 2004. This pro-forma information includes certain adjustments, including amortization related to fair value adjustments recorded in purchase accounting (in thousands, except per-share information): 106
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, 2004 JUNE 30, 2004 ------------------ ---------------- Net interest income ............ $92,733 $186,828 Other income ................... 37,523 75,177 Net income ..................... 39,024 76,980 Per Share: Net income (basic) .......... $ 0.24 $ 0.48 Net income (diluted) ........ 0.24 0.47
NOTE I - Subsequent Events ACQUISITION OF SVB FINANCIAL SERVICES, INC.: On July 1, 2005, the Corporation completed its acquisition of SVB Financial Services, Inc. (SVB). SVB was a $530 million bank holding company whose primary subsidiary was Somerset Valley Bank (Somerset Valley), which operates 11 community-banking offices in Somerset, Hunterdon and Middlesex Counties in New Jersey. Under the terms of the merger agreement, each of the approximately 4.1 million shares of SVB's common stock was acquired by the Corporation based on a "cash election merger" structure. Each SVB shareholder elected to receive 100% of the merger consideration in stock, 100% in cash, or a combination of stock and cash. As a result of the SVB shareholder elections, approximately 3.1 million of the SVB shares outstanding on the acquisition date were converted into shares of Corporation common stock, based on a fixed exchange ratio of 1.1899 shares of Corporation stock for each share of SVB stock. The remaining 984,000 shares of SVB stock were purchased for $21.00 per share, or a total of $20.7 million cash. In addition, each of the options to acquire SVB's stock were converted into options to purchase the Corporation's stock or were settled in cash, based on the election of each option holder and the terms of the merger agreement. As a result of the acquisition, SVB was merged into the Corporation and Somerset Valley became a wholly owned subsidiary. The acquisition is being accounted for using purchase accounting, which requires the Corporation to allocate the total purchase price of the acquisition to the assets acquired and liabilities assumed, based on their respective fair values at the acquisition date, with any remaining purchase price being recorded as goodwill. Resulting goodwill balances are then subject to an impairment test on at least an annual basis. The results of Somerset Valley's operations will be included in the Corporation's financial statements prospectively from the July 1, 2005 acquisition date. The total purchase price of approximately $90 million includes the value of the Corporation's stock issued ($65.7 million), cash paid ($20.7 million), SVB options converted or settled in cash ($2.5 million), and certain acquisition related costs ($1.0 million). The carrying value of the net assets of Somerset Valley as of July 1, 2005 was approximately $31.5 million and, therefore, the purchase price exceeded the carrying value of the net assets by approximately $58.5 million. The total purchase price will be allocated to the net assets acquired, based on acquisition date fair values. The Corporation expects to record a core deposit intangible asset and goodwill as a result of the acquisition accounting. The Corporation is in the process of completing its fair value analysis and will determine the allocation of the purchase price to the fair value of net assets acquired and goodwill during the third quarter of 2005. PENDING ACQUISITION - COLUMBIA BANCORP: On July 26, 2005, the Corporation entered into a merger agreement to acquire Columbia Bancorp (Columbia), of Columbia, Maryland. Columbia is a $1.3 billion bank holding company whose primary subsidiary is Columbia Bank, which operates 19 full-service community banking offices and five retirement community offices in Howard, Montgomery, Prince George's and Baltimore Counties and Baltimore City. 107 Under the terms of the merger agreement, each of the approximately 6.9 million shares of Columbia's common stock will be acquired based on a "cash election merger" structure. Each Columbia shareholder will have the ability to elect to receive 100% of the merger consideration in stock, 100% in cash, or a combination of stock and cash. Their elections will be subject to prorating to achieve a result where a minimum of 20% and a maximum of 50% of Columbia's outstanding shares will receive cash consideration. Those shares that will be converted into Corporation common stock would be exchanged based on a fixed exchange ratio of 2.325 shares of Corporation stock for each share of Columbia stock. Those shares of Columbia stock that will be converted into cash will be converted into a per-share amount of cash based on a fixed price of $42.48 per share of Columbia stock. In addition, each of the options to acquire Columbia's stock will be converted to options to purchase the Corporation's stock. The acquisition is subject to approval by both the Columbia shareholders and applicable bank regulatory authorities. The acquisition is expected to be completed during the first quarter of 2006. As a result of the acquisition, Columbia will be merged into the Corporation and Columbia Bank will become a wholly-owned subsidiary. The acquisition will be accounted for as a purchase. Purchase accounting requires the Corporation to allocate the total purchase price of the acquisition to the assets acquired and liabilities assumed, based on their respective fair values at the acquisition date, with any remaining acquisition cost being recorded as goodwill. Resulting goodwill balances are then subject to an impairment review on at least an annual basis. The results of Columbia's operations will be included in the Corporation's financial statements prospectively from the date of the acquisition. The total purchase price is estimated to be approximately $313 million, which includes cash expected to be paid, the value of the Corporation's stock expected to be issued, the value of Columbia's options to be converted and certain acquisition related costs. The net assets of Columbia as of June 30, 2005 were $91.3 million and, therefore, the estimated purchase price exceeded the carrying value of the net assets by $221.7 million. The total purchase price will be allocated to the net assets acquired as of the merger effective date, based on fair market values at that date. The Corporation expects to record a core deposit intangible asset and goodwill as a result of the acquisition accounting. NOTE J - DERIVATIVE FINANCIAL INSTRUMENTS - INTEREST RATE SWAPS As of June 30, 2005, interest rate swaps with a notional amount of $240 million were used to hedge certain long-term fixed rate certificate of deposit liabilities held at one of the Corporation's affiliate banks. The terms of the certificates of deposit and the interest rate swaps mirror each other and were committed to simultaneously. Under the terms of the swap agreements, the Corporation is the fixed rate receiver and the floating rate payer (generally tied to the three month London Interbank Offering Rate, or LIBOR, a common index used for setting rates between financial institutions). The combination of the interest rate swaps and the issuance of the certificates of deposit generates long-term floating rate funding for the Corporation. The interest rate swaps are classified as a cash flow hedge and the fair values of the derivatives are recorded as other assets or other liabilities. Changes in the fair values during the period are recorded in other comprehensive income (loss) to the extent the hedge is effective. Ineffectiveness resulting from differences between the changes in fair value or cash flows of the certificate of deposits and the interest rate swaps must be recorded in current period earnings. The Corporation's analysis of the effectiveness of the hedges indicated they were 97.7% effective as of June 30, 2005. As a result, a $109,000 and $46,000 credit to income for the three and six-month periods ended June 30, 2005, respectively, was recognized. During the six months ended June 30, 2005, the Corporation also recorded a $1.0 million other comprehensive loss (net of $540,000 tax effect) to recognize the fair value changes of derivatives resulting from the rising interest rate environment. NOTE K - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Those financial instruments include commitments to extend credit and letters of credit, which involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Corporation's Consolidated Balance Sheets. Exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the outstanding amount of those instruments. 108 The outstanding amounts of commitments to extend credit and letters of credit were as follows:
JUNE 30 --------------------- 2005 2004 --------- --------- (in thousands) ~~Commitments to extend credit..... 3,556,674 3,109,289 Standby letters of credit........ 548,713 518,961 Commercial letters of credit..... 21,471 20,869~~
NOTE L - ACCELERATED SHARE REPURCHASE On May 4, 2005, the Corporation purchased 4.3 million shares of its common stock from an investment bank at a total cost of $73.6 million, or $17.06 per share, under an "Accelerated Share Repurchase" program (ASR), which allowed the shares to be purchased immediately rather than over time. The investment bank, in turn, is repurchasing shares on the open market over a period that is determined by the average daily trading volume of our shares, among other factors. The Corporation will settle its position with the investment bank at the completion of the ASR by paying or receiving cash in an amount representing the difference between the initial price and the actual price of the shares repurchased. Through June 30, 2005, the investment bank had repurchased 193,000 shares at an average weighted cost of $17.73 per share. The Corporation expects the ASR to be completed in 2006. NOTE M - SUBORDINATED DEBT On March 28, 2005 the Corporation issued $100.0 million of ten-year subordinated notes, which mature April 1, 2015 and carry a fixed rate of 5.35%. Interest is paid semi-annually, commencing in October 2005. These notes were registered with the SEC on Form S-4, filed August 4, 2005. NOTE N - RECLASSIFICATIONS Certain amounts in the 2004 consolidated financial statements and notes have been reclassified to conform to the 2005 presentation. 109 EX-99.7 9 w15301exv99w7.txt ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (JUNE 30, 2005) EXHIBIT 99.7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (JUNE 30, 2005) Management's Discussion and Analysis of Financial Condition and Results of Operations (Management's Discussion) concerns Fulton Financial Corporation (the Corporation), a financial holding company incorporated under the laws of the Commonwealth of Pennsylvania in 1982, and its wholly owned subsidiaries. This discussion and analysis should be read in conjunction with the consolidated financial statements and notes presented in this report. FORWARD-LOOKING STATEMENTS The Corporation has made, and may continue to make, certain forward-looking statements with respect to its acquisition and growth strategies, management of net interest income and margin, the ability to realize gains on equity investments, allowance and provision for loan losses, expected levels of certain non-interest expenses and the liquidity position of the Corporation and Parent Company. The Corporation cautions that these forward-looking statements are subject to various assumptions, risks and uncertainties. Because of the possibility of changes in these assumptions, risks and uncertainties, actual results could differ materially from forward-looking statements. In addition to the factors identified herein, the following could cause actual results to differ materially from such forward-looking statements: pricing pressures on loan and deposit products, actions of bank and non-bank competitors, changes in local and national economic conditions, changes in regulatory requirements, actions of the Federal Reserve Board (FRB), creditworthiness of current borrowers, customers' acceptance of the Corporation's products and services and acquisition pricing and the ability of the Corporation to continue making acquisitions. The Corporation's forward-looking statements are relevant only as of the date on which such statements are made. By making any forward-looking statements, the Corporation assumes no duty to update them to reflect new, changing or unanticipated events or circumstances. RESULTS OF OPERATIONS Overview As a financial institution with a focus on traditional banking activities, the Corporation generates the majority of its revenue through net interest income, or the difference between interest income earned on loans and investments and interest paid on deposits and borrowings. Growth in net interest income is dependent upon balance sheet growth and maintaining or increasing the net interest margin, which is net interest income as a percentage of average interest-earning assets. The Corporation also generates revenue through fees earned on the various services and products offered to its customers and through sales of assets, such as loans, investments, or properties. Offsetting these revenue sources are provisions for credit losses on loans, other operating expenses and income taxes. The Corporation's net income for the second quarter of 2005 increased $3.8 million, or 10.1%, from $37.8 million in 2004 to $41.6 million in 2005. Diluted net income per share increased $0.03, or 12.5%, from $0.24 in 2004 to $0.27 in 2005. The percentage increase in net income per share was slightly lower than the net income increase as the average number of shares outstanding increased as a result of shares issued for acquisitions. The Corporation realized annualized returns on average assets of 1.46% and average equity of 13.94% during the second quarter of 2005. The annualized return on average tangible equity, which is net income, as adjusted for intangible amortization, net of tax, divided by average shareholders' equity, excluding goodwill and intangible assets, was 20.98% for the quarter. The Corporation adopted Statement of Financial Accounting Standards No. 123R, "Share-Based Payment" (Statement 123R) in the quarter ended September 30, 2005. Statement 123R requires that the fair value of equity awards to employees be recognized as compensation expense over the period during which an employee is required to provide service in exchange for such award. The Corporation adopted Statement 123R using "modified retrospective application" and, therefore, all financial information in this report has been restated to reflect the impact of adoption. See Note E, 110 "Stock-Based Compensation" in the Notes to Consolidated Financial Statements for information on the impact of adopting Statement 123R and its effect on prior periods. The increase in net income compared to the second quarter of 2004 resulted from an $11.2 million increase in net interest income and a $5.6 million increase in other income (excluding security gains), offset by a $3.9 million decrease in security gains, a $7.6 million increase in other expenses and a $1.6 million increase in income taxes. Net interest income growth resulted from increases in average earning assets, due to the acquisition of First Washington FinancialCorp (First Washington) in December 2004 (see "Acquisitions" below) and internal growth. The net interest margin increased 5.1% compared to the second quarter of 2004, compounding the impact of the earning asset growth. The following summarizes some of the more significant factors that influenced the Corporation's second quarter 2005 results. Interest Rates - Changes in the interest rate environment can have an effect on both the Corporation's net interest income and its non-interest income. The interest rate environment is commonly evaluated based on the shape of the U. S. Treasury yield curve (Yield Curve), which plots the yields on treasury issues over various maturity periods. During the past year, the Yield Curve has flattened, with short-term rates increasing and longer-term rates decreasing. Floating rate loans, short-term borrowings and savings and time deposit rates are generally influenced by short-term rates. The FRB raised the Federal funds rate nine times since June 2004, for a total increase of 225 basis points (from 1.00% to 3.25%). The Corporation's prime lending rate had a corresponding increase, from 4.00% to 6.25%. The increase in short-term rates initially benefited the Corporation as floating rate loans quickly adjusted to higher rates, while increases in deposit rates - which are more discretionary - were less pronounced. As a result, the Corporation realized an increase in net interest margin in the third and fourth quarters of 2004 and the first quarter of 2005. During the second quarter of 2005, competitive pressures resulted in increases in deposit rates. In addition, the Corporation issued $100 million of subordinated debt at 5.35% at the end of March 2005. As a result, the net interest margin decreased three basis points compared to the first quarter of 2005. With respect to longer-term rates, the 10-year treasury yield, which is a common benchmark for evaluating residential mortgage rates, decreased to 3.94% at June 30, 2005 as compared to 4.58% at June 30, 2004. Mortgage rates have been generally low over the past several years, generating strong refinance activity and significant gains for the Corporation as fixed rate residential mortgages are generally sold in the secondary market. With the decrease in long-term rates from the prior year, origination volume and the resulting gains on sales of these loans have remained strong, contributing to the Corporation's non-interest income. The Corporation manages its risk associated with changes in interest rates through the techniques documented in the "Market Risk" section of Management's Discussion. As of June 30, 2005, the Corporation projects improvements in net interest income in a rising rate environment. Increases in long-term rates, however, may have a detrimental impact on mortgage loan origination volumes and related gains on sales of mortgage loans. Earning Assets - The Corporation's interest-earning assets increased from 2004 to 2005 as a result of the First Washington acquisition and strong internal loan growth. This growth also contributed to the increase in net interest income. With improving regional economic conditions the Corporation is optimistic that internal loan growth in the short-term will continue to be strong. From 2004 to 2005, the Corporation experienced a shift in its composition of interest-earning assets from investments (23.3% of total average interest-earning assets in 2005, compared to 27.7% in 2004) to loans (74.8% in 2005 compared to 71.1% in 2004). This change resulted from strong loan demand being funded with the proceeds from maturing investment securities, primarily mortgage-backed securities. The movement to higher-yielding loans has had a positive effect on the Corporation's net interest income and net interest margin. 111 Asset Quality - Asset quality refers to the underlying credit characteristics of borrowers and the likelihood that defaults on contractual payments will result in charge-offs of account balances. Asset quality is generally a function of economic conditions, but can be managed through conservative underwriting and sound collection policies and procedures. The Corporation continued to maintain excellent asset quality, attributable to its credit culture and underwriting policies. Asset quality measures such as non-performing assets to total assets and net charge-offs to average loans improved in comparison to 2004, resulting in a lower provision for loan losses in the second quarter of 2005. While overall asset quality has remained strong, deterioration in quality of one or several significant accounts could have a detrimental impact and result in losses that may not be foreseeable based on current information. In addition, rising interest rates could increase the total payments of borrowers and could have a negative impact on the ability of some to pay according to the terms of their loans. Equity Markets - As noted in the "Market Risk" section of Management's Discussion, equity valuations can have an impact on the Corporation's financial performance. In particular, bank stocks account for a significant portion of the Corporation's equity investment portfolio. Gains on sales of these equities have been a recurring component of the Corporation's earnings for many years, including the second quarters of 2005 and 2004, with total gains of $1.4 million and $5.3 million, respectively. Declines in bank stock portfolio values could have a detrimental impact on the Corporation's ability to recognize gains from these sales. Acquisitions - In April 2004, the Corporation acquired Resource Bankshares Corporation (Resource), an $890 million financial holding company located in Virginia Beach, Virginia whose primary subsidiary was Resource Bank. This was the Corporation's first acquisition in Virginia, allowing it to enter a new geographic market. In December 2004, the Corporation acquired First Washington, a $490 million bank holding company located in Windsor, New Jersey whose primary subsidiary was First Washington State Bank (FWSB). Results for 2005 in comparison to 2004 were impacted by these acquisitions, as documented in the appropriate sections of Management's Discussion. In July 2005, the Corporation acquired SVB Financial Services, Inc. (SVB) of Somerville, New Jersey. SVB was a $530 million bank holding company whose primary subsidiary was Somerset Valley Bank, which operates 11 community-banking offices in Somerset, Hunterdon and Middlesex counties in New Jersey. The acquisition was completed on July 1, 2005. For additional information on the terms of this acquisition, see Note I, "Subsequent Events", in the Notes to Consolidated Financial Statements. Acquisitions have long been a supplement to the Corporation's internal growth. These recent acquisitions provide the opportunity for additional growth, as they will allow the Corporation's existing products and services to be sold in new markets. The Corporation's acquisition strategy focuses on high growth areas with strong market demographics and targets organizations that have a comparable corporate culture, strong performance and good asset quality, among other factors. Under its "super-community" banking philosophy, acquired organizations generally retain their status as separate legal entities, unless consolidation with an existing affiliate bank is practical. Back office functions are generally consolidated to maximize efficiencies. Merger and acquisition activity in the financial services industry has been very competitive in recent years, as evidenced by the prices paid for certain acquisitions. While the Corporation has been an active acquirer, management is committed to basing its pricing on rational economic models. Management will continue to focus on generating growth in the most cost-effective manner. Merger and acquisition activity also impacted the Corporation's capital and liquidity. In order to complete acquisitions, the Corporation must have strategies in place to maintain appropriate levels of capital and to provide necessary cash resources. In March 2005, the Corporation issued $100 million of subordinated debt, in part to support treasury stock repurchases related to acquisitions. This financing instrument also qualifies as a component of total regulatory capital. See additional information in the "liquidity" section of Management's Discussion. 112 Quarter Ended June 30, 2005 versus Quarter Ended June 30, 2004 Results for the second quarter of 2005 compared to the results of the second quarter of 2004 were impacted by the December 2004 acquisition of FWSB, whose results are included in 2005 amounts, but not in 2004. Net Interest Income Net interest income increased $11.2 million, or 12.6% ($7.0 million, or 7.9%, excluding FWSB), to $99.9 million in 2005 from $88.7 million in 2004. The increase was due to both average balance growth, with total earning assets increasing 7.0%, and an improving net interest margin. The average taxable equivalent yield on earning assets increased 69 basis points (a 13.5% increase) over 2004 while the cost of interest-bearing liabilities increased 62 basis points (a 37.1% increase). This resulted in a 19 basis point increase in net interest margin compared to the same period in 2004. The Corporation continues to manage its asset/liability position and interest rate risk through the methods discussed in the "Market Risk" section of Management's Discussion. The following table provides a comparative average balance sheet and net interest income analysis for the second quarter of 2005 as compared to the same period in 2004. Interest income and yields are presented on a tax-equivalent basis, using a 35% Federal tax rate. The discussion following this table is based on these tax-equivalent amounts. All dollar amounts are in thousands. 113
QUARTER ENDED JUNE 30, 2005 QUARTER ENDED JUNE 30, 2004 --------------------------------- --------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST RATE (1) BALANCE INTEREST RATE (1) ----------- -------- -------- ----------- -------- -------- ASSETS Interest-earning assets: Loans and leases.................. $ 7,823,737 $124,080 6.36% $ 6,946,626 $ 97,705 5.65% Taxable investment securities..... 1,965,683 18,257 3.71 2,299,834 19,652 3.39 Tax-exempt investment securities.. 341,044 4,227 4.96 272,891 3,822 5.60 Equity securities................. 129,980 1,341 4.14 137,528 1,196 3.49 ----------- -------- ---- ----------- -------- ---- Total investment securities.......... 2,436,707 23,825 3.91 2,710,253 24,670 3.62 Mortgage loans held for sale...... 152,503 2,699 7.08 115,658 1,962 6.79 Other interest-earning assets..... 47,819 348 2.90 6,717 19 1.09 ----------- -------- ---- ----------- -------- ---- Total interest-earning assets........ 10,460,766 150,952 5.79% 9,779,254 124,356 5.10% Noninterest-earning assets: Cash and due from banks........... 342,592 332,653 Premises and equipment............ 152,123 130,737 Other assets...................... 554,557 448,946 Less: Allowance for loan losses... (91,209) (86,800) ----------- ----------- Total Assets................... $11,418,829 $10,604,790 =========== =========== LIABILITIES AND EQUITY Interest-bearing liabilities: Demand deposits................... $ 1,484,772 $ 3,309 0.89% $ 1,362,761 $ 1,634 0.48% Savings deposits.................. 1,986,909 5,859 1.18 1,857,175 2,637 0.57 Time deposits..................... 3,019,818 21,936 2.91 2,841,569 18,074 2.56 ----------- -------- ---- ----------- -------- ---- Total interest-bearing deposits...... 6,491,499 31,104 1.92 6,061,505 22,345 1.48 Short-term borrowings............. 1,180,975 7,914 2.68 1,282,657 3,135 0.98 Long-term debt.................... 841,650 9,668 4.59 656,803 7,838 4.70 ----------- -------- ---- ----------- -------- ---- Total interest-bearing liabilities... 8,514,124 48,686 2.29% 8,000,965 33,318 1.67% Noninterest-bearing liabilities: Demand deposits................... 1,567,611 1,386,770 Other............................. 139,888 114,219 ----------- ----------- Total Liabilities.............. 10,221,623 9,501,954 Shareholders' equity................. 1,197,206 1,102,836 ----------- ----------- Total Liabilities and Shareholders' Equity........ $11,418,829 $10,604,790 =========== =========== Net interest income/ net interest margin (FTE)......... 102,266 3.92% 91,038 3.73% ==== ==== Tax equivalent adjustment............ (2,341) (2,332) -------- -------- Net interest income.................. $ 99,925 $ 88,706 ======== ========
(1) Presented on a fully taxable equivalent (FTE) basis using a 35% Federal tax rate. 114 The following table summarizes the changes in interest income and expense due to changes in average balances (volume) and changes in rates:
2005 VS. 2004 INCREASE (DECREASE) DUE TO CHANGE IN ------------------------------ VOLUME RATE NET -------- -------- -------- (in thousands) Interest income on: Loans and leases ....................... $13,280 $13,095 $26,375 Taxable investment securities .......... (2,981) 1,586 (1,395) Tax-exempt investment securities ....... 894 (489) 405 Equity securities ...................... (68) 213 145 Mortgage loans held for sale ........... 654 83 737 Other interest-earning assets .......... 262 67 329 ------- ------- ------- Total interest-earning assets ....... $12,041 $14,555 $26,596 ======= ======= ======= Interest expense on: Demand deposits ........................ $ 159 $ 1,516 $ 1,675 Savings deposits ....................... 198 3,024 3,222 Time deposits .......................... 1,201 2,661 3,862 Short-term borrowings .................. (268) 5,047 4,779 Long-term debt ......................... 2,153 (323) 1,830 ------- ------- ------- Total interest-bearing liabilities .. $ 3,443 $11,925 $15,368 ======= ======= =======
Interest income increased $26.6 million, or 21.4%, mainly as a result of both the increased yield on interest earning assets and growth in average balances. Interest income increased $14.6 million as a result of the 69 basis point increase in rates. An additional $12.0 million increase was realized from the 7.0% increase in average balances. Average loans increased $877.1 million, or 12.6%. The following presents the growth in average loans by category:
THREE MONTHS ENDED INCREASE JUNE 30 (DECREASE) ----------------------- ----------------- 2005 2004 $ % ---------- ---------- --------- ----- (dollars in thousands) Commercial - industrial and financial ... $1,970,926 $1,776,940 $ 193,986 10.9% Commercial - agricultural ............... 319,853 331,575 (11,722) (3.5) Real estate - commercial mortgage ....... 2,537,606 2,216,617 320,989 14.5 Real estate - commercial construction ... 388,113 312,312 75,801 24.3 Real estate - residential mortgage ...... 570,061 519,353 50,708 9.8 Real estate - residential construction .. 344,823 241,053 103,770 43.0 Real estate - home equity ............... 1,127,228 959,267 167,961 17.5 Consumer ................................ 502,031 517,226 (15,195) (2.9) Leasing and other ....................... 63,096 72,283 (9,187) (12.7) ---------- ---------- --------- ----- Total ................................ $7,823,737 $6,946,626 $ 877,111 12.6% ========== ========== ========= =====
115 FWSB contributed $251.6 million to the increase in average loans, presented by type in the following table:
THREE MONTHS ENDED JUNE 30 --------------- 2005 2004 INCREASE -------- ---- -------- (in thousands) Commercial - industrial and financial ... $ 51,553 $-- $ 51,553 Commercial - agricultural ............... -- -- -- Real estate - commercial mortgage ....... 129,435 -- 129,435 Real estate - commercial construction ... 19,894 -- 19,894 Real estate - residential mortgage ...... 11,430 -- 11,430 Real estate - residential construction .. 258 -- 258 Real estate - home equity ............... 34,913 -- 34,913 Consumer ................................ 3,737 -- 3,737 Leasing and other ....................... 397 -- 397 -------- --- -------- Total ................................ $251,617 $-- $251,617 ======== === ========
The following table presents the growth in average loans, by type, excluding the average balances contributed by FWSB:
THREE MONTHS INCREASE ENDED JUNE 30 (DECREASE) ----------------------- ---------------- 2005 2004 $ % ---------- ---------- -------- ----- (dollars in thousands) Commercial - industrial and financial ... $1,919,373 $1,776,940 $142,433 8.0% Commercial - agricultural ............... 319,853 331,575 (11,722) (3.5) Real estate - commercial mortgage ....... 2,408,171 2,216,617 191,554 8.6 Real estate - commercial construction ... 368,219 312,312 55,907 17.9 Real estate - residential mortgage ...... 558,631 519,353 39,278 7.6 Real estate - residential construction .. 344,565 241,053 103,512 42.9 Real estate - home equity ............... 1,092,315 959,267 133,048 13.9 Consumer ................................ 498,294 517,226 (18,932) (3.7) Leasing and other ....................... 62,699 72,283 (9,584) (13.3) ---------- ---------- -------- ----- Total ................................ $7,572,120 $6,946,626 $625,495 9.0% ========== ========== ======== =====
Excluding the impact of FWSB, loan growth continued to be particularly strong in the commercial and commercial mortgage categories, which together increased $334.0 million, or 8.4%. Commercial agricultural loans decreased $11.7 million, or 3.5% due to agricultural customers using excess funds to pay down loans, instead of expanding their facilities. Residential mortgage and residential construction increased $142.8 million, or 18.8%, mainly due to an increase in residential construction lending at Resource Bank. Home equity loans increased $133.0 million, or 13.9%, due to promotional efforts and customers using home equity loans as a cost-effective refinance alternative. Consumer loans decreased slightly, reflecting repayment of these loans with tax-advantaged residential mortgage or home equity loans. The average yield on loans during the second quarter of 2005 was 6.36%, a 71 basis point, or 12.6%, increase over 2004. This reflects the impact of a significant portfolio of floating rate loans, which reprice to higher rates when interest rates rise. Average investment securities decreased $273.5 million, or 10.1%. Excluding the impact of FWSB, this decrease was $506.7 million, or 18.7%. During the past twelve months, maturities of investment securities exceeded purchases of new investments, with the resulting net inflow of funds used to support loan growth. The average yield on investment securities increased 29 basis points, from 3.62% in 2004 to 3.91% in 2005. 116 Interest expense increased $15.4 million, or 46.1%, to $48.7 million in the second quarter of 2005, from $33.3 million in the second quarter of 2004. Interest expense increased $11.9 million as a result of the 62 basis point increase in the cost of total interest-bearing liabilities, with the remaining $3.4 million increase due to an increase in average balances, The cost of interest-bearing deposits increased 44 basis points, or 29.7%, from 1.48% in 2004 to 1.92% in 2005. This increase was due to rising rates in general as a result of the FRB's rate increases over the past twelve months. The following table presents average deposits by category:
THREE MONTHS ENDED JUNE 30 INCREASE ----------------------- --------------- 2005 2004 $ % ---------- ---------- -------- ---- (dollars in thousands) Noninterest-bearing demand .. $1,567,611 $1,386,770 $180,841 13.0% Interest-bearing demand ..... 1,484,771 1,362,761 122,010 9.0 Savings/money market ........ 1,986,909 1,857,174 129,735 7.0 Time deposits ............... 3,019,819 2,841,570 178,249 6.3 ---------- ---------- -------- ---- Total .................... $8,059,110 $7,448,275 $610,836 8.2% ========== ========== ======== ====
The FWSB acquisition accounted for approximately $419.6 million of the increase in average balances. The following table presents the average balance impact of the acquisition, by type:
THREE MONTHS ENDED JUNE 30 --------------- 2005 2004 INCREASE -------- ---- -------- (in thousands) Noninterest-bearing demand .. $ 79,743 $-- $ 79,743 Interest-bearing demand ..... 54,268 -- 54,268 Savings/money market ........ 51,082 -- 51,082 Time deposits ............... 234,556 -- 234,556 -------- --- -------- Total .................... $419,649 $-- $419,649 ======== === ========
The following table presents the growth in average deposits, by type, excluding the contribution of FWSB:
THREE MONTHS ENDED JUNE 30 INCREASE ----------------------- --------------- 2005 2004 $ % ---------- ---------- -------- ---- (dollars in thousands) Noninterest-bearing demand .. $1,487,868 $1,386,770 $101,098 7.3% Interest-bearing demand ..... 1,430,503 1,362,761 67,742 5.0 Savings/money market ........ 1,935,827 1,857,174 78,653 4.2 Time deposits ............... 2,785,263 2,841,570 (56,307) (2.0) ---------- ---------- -------- ---- Total .................... $7,639,461 $7,448,276 $191,185 2.6% ========== ========== ======== ====
Average borrowings increased $83.2 million, or 4.3%, to $2.0 billion in the second quarter of 2005. FWSB added $51.3 million to short-term borrowings and $9.5 million to long-term debt. Excluding FWSB, average short-term borrowings decreased $152.9 million, or 11.9%, to $1.1 billion in 2005, while average long-term debt increased $175.4 million, or 26.7%, to $832.2 million. The decrease in short-term borrowings was mainly due to a decrease in Federal funds purchased as funds from deposits and investment maturities were sufficient to fund increases in loans. The increase in long-term debt was partially due to the Corporation's issuance of $100.0 million of ten-year subordinated notes in March 117 2005. The remaining increase was mainly due to an increase in Federal Home Loan Bank Advances. The Corporation locked in longer-term rates in anticipation of increasing rates. As with the U.S. Treasury yields, longer-term FHLB rates have decreased over the last year. Provision and Allowance for Loan Losses The following table summarizes loans outstanding (net of unearned income):
JUNE 30 December 31 June 30 2005 2004 2004 ---------- ----------- ---------- (in thousands) Commercial - industrial and financial.... $1,991,480 $1,946,962 $1,818,568 Commercial - agricultural................ 322,791 326,176 324,466 Real-estate - commercial mortgage........ 2,556,990 2,461,016 2,240,228 Real-estate - commercial construction.... 396,159 348,846 314,903 Real-estate - residential mortgage....... 558,845 543,072 504,320 Real-estate - residential construction... 347,614 277,940 245,963 Real estate - home equity................ 1,141,749 1,108,249 1,004,532 Consumer................................. 485,489 506,290 522,574 Leasing and other........................ 60,391 65,996 66,757 ---------- ---------- ---------- Total................................. $7,861,508 $7,584,547 $7,042,311 ========== ========== ==========
118 The following table summarizes the activity in the Corporation's allowance for loan losses:
THREE MONTHS ENDED JUNE 30 ----------------------- 2005 2004 ---------- ---------- (dollars in thousands) Loans outstanding at end of period (net of unearned)... $7,861,508 $7,042,311 ========== ========== Daily average balance of loans and leases.............. $7,823,737 $6,946,626 ========== ========== Balance at beginning of period......................... $ 90,127 $ 78,271 Loans charged-off: Commercial, financial and agricultural.............. 729 510 Real estate - mortgage.............................. 54 203 Consumer............................................ 836 808 Leasing and other................................... 41 48 ---------- ---------- Total loans charged-off............................. 1,660 1,569 ---------- ---------- Recoveries of loans previously charged-off: Commercial, financial and agricultural.............. 479 574 Real estate - mortgage.............................. 467 114 Consumer............................................ 242 412 Leasing and other................................... 22 25 ---------- ---------- Total recoveries.................................... 1,210 1,125 ---------- ---------- Net loans charged-off.................................. 450 444 Provision for loan losses.............................. 725 800 Allowance purchased (Resource)......................... -- 7,912 ---------- ---------- Balance at end of period............................... $ 90,402 $ 86,539 ========== ========== Net charge-offs to average loans (annualized).......... 0.02% 0.03% ========== ========== Allowance for loan losses to loans outstanding......... 1.15% 1.23% ========== ==========
The following table summarizes the Corporation's non-performing assets:
JUNE 30 DECEMBER 31 JUNE 30 2005 2004 2004 ------- ----------- ------- (dollars in thousands) Non-accrual loans........................ $20,820 $22,574 $21,961 Loans 90 days past due and accruing...... 7,453 8,318 9,314 Other real estate owned (OREO)........... 3,478 2,209 1,119 ------- ------- ------- Total non-performing assets.............. $31,751 $33,101 $32,394 ======= ======= ======= Non-accrual loans/Total loans............ 0.26% 0.30% 0.31% Non-performing assets/Total assets....... 0.27% 0.30% 0.31% Allowance/Non-performing loans........... 320% 290% 277%
The provision for loan losses for the second quarter of 2005 totaled $725,000, a decrease of $75,000, or 9.4%, from the same period in 2004. Net charge-offs totaled $450,000, or 0.02% of average loans on an annualized basis, during the 119 second quarter of 2005, compared to $444,000 or 0.03% in net charge-offs, for the second quarter of 2004. Non-performing assets decreased to $31.8 million, or 0.27% of total assets, at June 30, 2005, from $32.4 million, or 0.31% of total assets, at June 30, 2004. Management believes that the allowance balance of $90.4 million at June 30, 2005 is sufficient to cover losses inherent in the loan portfolio on that date and is appropriate based on applicable accounting standards. Other Income The following table presents the components of other income:
THREE MONTHS ENDED JUNE 30 INCREASE (DECREASE) ------------------ ------------------- 2005 2004 $ % ------- ------- ------- ----- (in thousands) Investment management and trust services ... $ 8,966 $ 8,637 $ 329 3.8% Service charges on deposit accounts ........ 9,960 9,929 31 0.3 Other service charges and fees ............. 7,142 4,970 2,172 43.7 Gain on sale of mortgage loans ............. 6,290 6,050 240 4.0 Investment securities gains ................ 1,418 5,349 (3,931) (73.5) Gain on sale of deposits ................... 2,201 -- 2,201 N/A Other ...................................... 2,338 1,727 611 35.4 ------- ------- ------- ----- Total ................................... $38,315 $36,662 $ 1,653 4.5% ======= ======= ======= =====
Total other income for the quarter ended June 30, 2005 was $38.3 million, an increase of $1.7 million, or 4.5%, over the comparable period in 2004. Excluding investment securities gains, which decreased from $5.3 million in 2004 to $1.4 million in 2005, other income increased $5.6 million, or 17.8%. Other service charges and fees increased $2.2 million, or 43.7%, due to a one-time increase in credit card merchant fee income and fees on letters of credit. During the second quarter of 2005, the Corporation sold three branches and related deposits in two separate transactions. The sale resulted in $2.2 million of gains primarily from the premiums paid on the $36.7 million of deposits sold. The $611,000 increase in other income resulted from growth in various categories. Investment securities gains decreased $3.9 million, or 73.5%. Investment securities gains during the second quarter of 2005 consisted of net realized gains of $1.4 million on the sale of equity securities and $56,000 on the sale of available for sale debt securities. Investment securities gains during the second quarter of 2004 consisted of net realized gains of $3.3 million on the sale of equity securities and $2.0 million on the sale of available for sale debt securities. 120 Other Expenses The following table presents the components of other expenses:
THREE MONTHS ENDED INCREASE JUNE 30 (DECREASE) ------------------ -------------- 2005 2004 $ % ------- ------- ------ ----- (dollars in thousands) Salaries and employee benefits ... $45,235 $41,894 $3,341 8.0% Net occupancy expense ............ 6,549 5,859 690 11.8 Equipment expense ................ 2,888 2,749 139 5.1 Data processing .................. 3,321 2,868 453 15.8 Advertising ...................... 2,276 1,914 362 18.9 Intangible amortization .......... 1,168 1,356 (188) (13.9) Other ............................ 16,752 13,957 2,795 20.0 ------- ------- ------ ----- Total ......................... $78,189 $70,597 $7,592 10.8% ======= ======= ====== =====
Total other expenses increased $7.6 million, or 10.8%, in 2005, including $3.4 million due to FWSB, detailed as follows:
THREE MONTHS ENDED JUNE 30 ------------------ 2005 2004 INCREASE ------ ---- -------- (in thousands) Salaries and employee benefits ... $1,291 $-- $1,291 Net occupancy expense ............ 358 -- 358 Equipment expense ................ 157 -- 157 Data processing .................. 122 -- 122 Advertising ...................... 55 -- 55 Intangible amortization .......... 154 -- 154 Other ............................ 1,269 -- 1,269 ------ --- ------ Total ......................... $3,406 $-- $3,406 ====== === ======
The following table presents the components of other expenses, excluding the amounts contributed by FWSB, for the quarter ended June 30, 2005:
THREE MONTHS ENDED INCREASE JUNE 30 (DECREASE) ------------------ -------------- 2005 2004 $ % ------- ------- ------ ----- (dollars in thousands) Salaries and employee benefits ... $43,944 $41,894 $2,050 4.9% Net occupancy expense ............ 6,191 5,859 332 5.7 Equipment expense ................ 2,731 2,749 (18) (0.7) Data processing .................. 3,199 2,868 331 11.5 Advertising ...................... 2,221 1,914 307 16.0 Intangible amortization .......... 1,014 1,356 (342) (25.2) Other ............................ 15,483 13,957 1,526 10.9 ------- ------- ------ ----- Total ......................... $74,783 $70,597 $4,186 5.9% ======= ======= ====== =====
121 The discussion that follows addresses changes in other expenses, excluding FWSB. Salaries and employee benefits increased $2.1 million, or 4.9%, in comparison to the second quarter of 2004. The salary expense component increased $1.4 million, or 4.2%, driven by salary increases for existing employees and an increase in average full-time equivalent employees from 3,298 in the second quarter of 2004 to 3,317 in the second quarter of 2005. Employee benefits increased $626,000, or 7.6%, in comparison to the second quarter of 2004 driven mainly by increases in healthcare costs. Net occupancy expense increased $332,000, or 5.7%, to $6.2 million in 2005. The increase resulted from the expansion of the branch network and the addition of new office space for existing affiliates. Equipment expense decreased $18,000, or 0.7%, due to lower depreciation expense as certain equipment became fully depreciated. Data processing expense, which consists mainly of fees paid for outsourced back office systems, increased $331,000, or 11.5%, due to the continued growth in transaction volumes. Advertising expense increased $307,000, or 16.0%, due to promotional campaigns particularly in retail lines of business. Intangible amortization decreased $342,000, or 25.2%, in the second quarter of 2005. Intangible amortization consists of the amortization of unidentifiable intangible assets related to branch and loan acquisitions, core deposit intangible assets, and other identified intangible assets. Since many of these intangibles are amortized using accelerated methods, amortization expense of existing intangibles decreases over time. Other expense increased $1.5 million, or 10.9%, due to the timing of certain expenses. Income Taxes Income tax expense for the second quarter of 2005 was $17.7 million, a $1.6 million, or 9.6%, increase from $16.2 million in 2004. The Corporation's effective tax rate for the second quarter of 2005 was approximately 29.9%, as compared to 30.0% in 2004. The effective rate is lower than the Federal statutory rate of 35% due mainly to investments in tax-free municipal securities and federal tax credits from investments in low and moderate income housing partnerships. Six Months Ended June 30, 2005 versus Six Months Ended June 30, 2004 Results for the first six months of 2005 when compared to the results of 2004 were impacted by the acquisitions of Resource Bank in April 2004 and FWSB in December 2004. In the following discussion these are collectively referred to as the "Acquisitions". Net Interest Income Net interest income increased $26.5 million, or 15.4%, to $198.2 million in 2005 from $171.7 million in 2004. This increase was due to both average balance growth, with total earning assets increasing 10.2%, and an improving net interest margin. The average yield on earning assets increased 57 basis points (an 11.1% increase) over 2004 while the cost of interest-bearing liabilities increased 51 basis points (a 30.5% increase). This resulted in an 18 basis point increase in net interest margin compared to the same period in 2004. The Corporation continues to manage its asset/liability position and interest rate risk through the methods discussed in the "Market Risk" section of Management's Discussion. The following table provides a comparative average balance sheet and net interest income analysis for the first six months of 2005 as compared to the same period in 2004. Interest income and yields are presented on a tax-equivalent basis, using a 35% Federal tax rate. The discussion following this table is based on these tax-equivalent amounts. All dollar amounts are in thousands. 122
SIX MONTHS ENDED JUNE 30, 2005 SIX MONTHS ENDED JUNE 30, 2004 ----------------------------------- ----------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST (1) RATE (1) BALANCE INTEREST (1) RATE (1) ----------- ------------ -------- ----------- ------------ -------- ASSETS Interest-earning assets: Loans and leases.................. $ 7,749,797 $241,461 6.28% $ 6,567,307 $187,000 5.72% Taxable investment securities..... 1,974,723 36,518 3.69 2,351,126 41,388 3.49 Tax-exempt investment securities.. 338,215 8,481 5.02 274,517 7,631 5.56 Equity securities................. 126,907 2,611 4.13 134,540 2,389 3.56 ----------- -------- ---- ----------- -------- ---- Total investment securities.......... 2,439,845 47,610 3.90 2,760,183 51,408 3.70 Mortgage loans held for sale...... 132,670 4,511 6.80 65,435 2,201 6.73 Other interest-earning assets..... 38,313 524 2.74 5,231 29 1.12 ----------- -------- ---- ----------- -------- ---- Total interest-earning assets..... 10,360,625 294,106 5.71% 9,398,156 240,638 5.14% Noninterest-earning assets: Cash and due from banks........... 332,747 316,721 Premises and equipment............ 150,579 126,083 Other assets...................... 562,889 383,127 Less: Allowance for loan losses... (90,851) (82,766) ----------- ----------- Total Assets................... $11,315,989 $10,141,321 =========== =========== LIABILITIES AND EQUITY Interest-bearing liabilities: Demand deposits................... $ 1,489,850 $ 6,279 0.85% $ 1,315,716 $ 2,989 0.46% Savings deposits.................. 1,949,573 10,324 1.07 1,808,638 5,143 0.57 Time deposits..................... 3,008,161 42,309 2.84 2,636,657 34,563 2.64 ----------- -------- ---- ----------- -------- ---- Total interest-bearing deposits...... 6,447,584 58,912 1.84 5,761,011 42,695 1.49 Short-term borrowings............. 1,210,053 14,738 2.44 1,313,972 6,462 0.98 Long-term debt.................... 761,992 17,598 4.64 613,439 15,130 4.85 ----------- -------- ---- ----------- -------- ---- Total interest-bearing liabilities... 8,419,629 91,248 2.18% 7,688,422 64,287 1.67% Noninterest-bearing liabilities: Demand deposits................... 1,538,526 1,322,155 Other............................. 133,554 103,784 ----------- ----------- Total Liabilities.............. 10,091,709 9,114,361 Shareholders' equity................. 1,224,280 1,026,960 ----------- ----------- Total Liabilities and Shareholders' Equity........ $11,315,989 $10,141,321 =========== =========== Net interest income/net interest margin (FTE)...................... 202,858 3.94% 176,351 3.76% ==== ==== Tax equivalent adjustment............ (4,685) (4,678) -------- -------- Net interest income.................. $198,173 $171,673 ======== ========
(1) Presented on a fully taxable equivalent (FTE) basis using a 35% Federal tax rate. 123 The following table summarizes the changes in interest income and expense due to changes in average balances (volume) and changes in rates:
2005 VS. 2004 INCREASE (DECREASE) DUE TO CHANGE IN --------------------------- VOLUME RATE NET ------- ------- ------- (in thousands) Interest income on: Loans and leases ....................... $35,361 $19,100 $54,461 Taxable investment securities .......... (6,958) 2,088 (4,870) Tax-exempt investment securities ....... 1,631 (781) 850 Equity securities ...................... (143) 365 222 Mortgage loans held for sale ........... 2,280 30 2,310 Other interest-earning assets .......... 401 94 495 ------- ------- ------- Total interest-earning assets ....... $32,572 $20,896 $53,468 ======= ======= ======= Interest expense on: Demand deposits ........................ $ 438 $ 2,852 $ 3,290 Savings deposits ....................... 427 4,754 5,181 Time deposits .......................... 5,033 2,713 7,746 Short-term borrowings .................. (549) 8,825 8,276 Long-term debt ......................... 3,442 (974) 2,468 ------- ------- ------- Total interest-bearing liabilities .. $ 8,791 $18,170 $26,961 ======= ======= =======
Interest income increased $53.5 million, or 22.2%, due to a combination of increases in average interest-earning assets, which contributed $32.6 million to the increase, and increases in average yields, which resulted in a $20.9 million increase. Average interest-earning assets increased $962.5 million, or 10.2%, mainly as a result of a $709.0 million contribution from the Acquisitions. Internal growth in average loans of $474.4 million was more than offset by a $612.3 million decline in average investments. However, this change in the mix of earning assets contributed to the 57 basis point increase in average yields. The Corporation's average loan portfolio increased $1.2 billion, or 18.0%, as shown by type in the following table:
SIX MONTHS ENDED JUNE 30 INCREASE (DECREASE) ----------------------- ------------------- 2005 2004 $ % ---------- ---------- ---------- ----- (dollars in thousands) Commercial - industrial and financial ... $1,987,810 $1,691,552 $ 296,258 17.5% Commercial - agricultural ............... 323,257 340,386 (17,129) (5.0) Real estate - commercial mortgage ....... 2,488,974 2,115,053 373,921 17.7 Real estate - commercial construction ... 375,603 283,068 92,535 32.7 Real estate - residential mortgage ...... 565,272 480,601 84,671 17.6 Real estate - residential construction .. 327,459 142,258 185,201 130.2 Real estate - home equity ............... 1,117,139 928,917 188,222 20.3 Consumer ................................ 501,252 515,086 (13,834) (2.7) Leasing and other ....................... 63,031 70,386 (7,355) (10.4) ---------- ---------- ---------- ----- Total ................................ $7,749,797 $6,567,307 $1,182,490 18.0% ========== ========== ========== =====
124 The Acquisition contributed approximately $709.0 million to the increase in average balances. The following table presents the average balance impact of the Acquisitions, by type:
SIX MONTHS ENDED JUNE 30 --------------------- 2005 2004 INCREASE ---------- -------- -------- (in thousands) Commercial - industrial and financial ... $ 187,095 $ 52,853 $134,242 Commercial - agricultural ............... 1,601 195 1,406 Real estate - commercial mortgage ....... 298,143 82,991 215,152 Real estate - commercial construction ... 108,154 35,752 72,402 Real estate - residential mortgage ...... 90,158 34,625 55,533 Real estate - residential construction .. 270,978 98,694 172,284 Real estate - home equity ............... 51,971 4,510 47,461 Consumer ................................ 6,240 1,329 4,911 Leasing and other ....................... 7,018 1,363 5,655 ---------- -------- -------- Total ................................ $1,021,358 $312,312 $709,046 ========== ======== ========
The following table presents the growth in average loans, by type, excluding the average balances contributed by the Acquisitions:
SIX MONTHS ENDED JUNE 30 INCREASE (DECREASE) ----------------------- ------------------- 2005 2004 $ % ---------- ---------- -------- ----- (dollars in thousands) Commercial - industrial and financial ... $1,800,715 $1,638,699 $162,016 9.9% Commercial - agricultural ............... 321,656 340,191 (18,535) (5.4) Real estate - commercial mortgage ....... 2,190,831 2,032,062 158,769 7.8 Real estate - commercial construction ... 267,449 247,316 20,133 8.1 Real estate - residential mortgage ...... 475,114 445,976 29,138 6.5 Real estate - residential construction .. 56,481 43,564 12,917 29.7 Real estate - home equity ............... 1,065,168 924,407 140,761 15.2 Consumer ................................ 495,012 513,757 (18,745) (3.6) Leasing and other ....................... 56,013 69,023 (13,010) (18.8) ---------- ---------- -------- ----- Total ................................ $6,728,439 $6,254,995 $473,444 7.6% ========== ========== ======== =====
Excluding the impact of the Acquisitions, average loan growth continued to be particularly strong in the commercial and commercial mortgage categories, which together increased $320.8 million, or 8.7%. Commercial agricultural loans decreased $18.5 million, or 5.4% due to agricultural customers using excess funds to pay down loans, instead of expanding their facilities. Residential mortgage and residential construction increased $42.1 million, or 8.6%. Home equity loans increased $140.8 million, or 15.2%, due to promotional efforts and customers using home equity loans as a cost-effective refinance alternative. Consumer loans decreased slightly, reflecting repayment of these loans with tax-advantaged residential mortgage or home equity loans. Leasing and other loans decreased $13.0 million, or 18.8%. The average yield on loans during the first six months of 2005 was 6.28%, a 56 basis point, or 9.8%, increase over 2004. This reflects the impact of a significant portfolio of floating rate loans, which reprice to higher rates when interest rates rise, as they have over the past twelve months. 125 Average investment securities decreased $320.3 million, or 11.6%. Excluding the impact of the Acquisitions, this decrease was $612.3 million, or 22.6%. During the past twelve months, maturities of investment securities exceeded purchases as funds were used to support loan growth and reduce short-term borrowings. The average yield on investment securities increased 20 basis points from 3.70% in 2004 to 3.90% in 2005. Interest expense increased $27.0 million, or 41.9%, to $91.2 million in the first six months of 2005 from $64.3 million in the first six months of 2004. Interest expense increased $18.2 million as a result of the 51 basis point increase in the cost of total interest-bearing liabilities, with the remaining increase of $8.8 million due to an increase in average balances. The cost of interest-bearing deposits increased 35 basis points, or 23.5%, from 1.49% in 2004 to 1.84% in 2005. This increase was due to rising rates in general as a result of the FRB's rate increases over the past twelve months. The following table presents the growth in average deposits by category:
SIX MONTHS ENDED JUNE 30 INCREASE ----------------------- --------------- 2005 2004 $ % ---------- ---------- -------- ---- (dollars in thousands) Noninterest-bearing demand .. $1,538,526 $1,322,155 $216,371 16.4% Interest-bearing demand ..... 1,489,850 1,315,716 174,134 13.2 Savings/money market ........ 1,949,573 1,808,638 140,935 7.8 Time deposits ............... 3,008,161 2,636,657 371,504 14.1 ---------- ---------- -------- ---- Total .................... $7,986,110 $7,083,166 $902,944 12.7% ========== ========== ======== ====
The Acquisitions accounted for approximately $809.1 million of the increase in average balances. The following table presents the average balance impact of the Acquisitions, by type:
SIX MONTHS ENDED JUNE 30 --------------------- 2005 2004 INCREASE ---------- -------- -------- (in thousands) Noninterest-bearing demand .. $ 119,004 $ 19,187 $ 99,817 Interest-bearing demand ..... 103,032 27,453 75,579 Savings/money market ........ 161,079 22,391 138,688 Time deposits ............... 714,762 219,739 495,023 ---------- -------- -------- Total .................... $1,097,877 $288,770 $809,107 ========== ======== ========
The following table presents the growth in average deposits, by type, excluding the contribution of the Acquisitions:
SIX MONTHS ENDED JUNE 30 INCREASE (DECREASE) ----------------------- ------------------- 2005 2004 $ % ---------- ---------- --------- ------- (dollars in thousands) Noninterest-bearing demand .. $1,419,522 $1,302,968 $ 116,554 8.9% Interest-bearing demand ..... 1,386,818 1,288,263 98,555 7.7 Savings/money market ........ 1,788,494 1,786,247 2,247 0.1 Time deposits ............... 2,293,399 2,416,918 (123,519) (5.1) ---------- ---------- --------- ---- Total .................... $6,888,233 $6,794,396 $ 93,837 1.4% ========== ========== ========= ====
126 Average borrowings increased $44.6 million, or 2.3%, to $2.0 billion in the first six months of 2005. The Acquisitions added $160.5 million to short-term borrowings and $75.7 million to long-term debt. Excluding the Acquisitions, average short-term borrowings decreased $264.4 million, or 21.3%, to $978.3 million in 2005, while average long-term debt increased $72.8 million, or 12.7%, to $647.1 million. The decrease in short-term borrowings was mainly due to a decrease in Federal funds purchased as funds from deposit growth and investment maturities were sufficient to fund increases in loans. The increase in long-term debt was partially due to the Corporation's issuance of $100.0 million of ten-year subordinated notes in March 2005. Provision and Allowance for Loan Losses The following table summarizes the activity in the Corporation's allowance for loan losses:
SIX MONTHS ENDED JUNE 30 ----------------------- 2005 2004 ---------- ---------- (dollars in thousands) Loans outstanding at end of period (net of unearned) .. $7,861,508 $7,042,311 ========== ========== Daily average balance of loans and leases ............. $7,749,797 $6,567,307 ========== ========== Balance at beginning of period ........................ $ 89,627 $ 77,700 Loans charged-off: Commercial, financial and agricultural ............. 1,552 1,489 Real estate - mortgage ............................. 241 967 Consumer ........................................... 1,601 1,595 Leasing and other .................................. 85 181 ---------- ---------- Total loans charged-off ............................ 3,479 4,232 ---------- ---------- Recoveries of loans previously charged-off: Commercial, financial and agricultural ............. 1,176 1,091 Real estate - mortgage ............................. 917 560 Consumer ........................................... 608 911 Leasing and other .................................. 28 57 ---------- ---------- Total recoveries ................................... 2,729 2,619 ---------- ---------- Net loans charged-off ................................. 750 1,613 Provision for loan losses ............................. 1,525 2,540 Allowance purchased (Resource) ........................ -- 7,912 ---------- ---------- Balance at end of period .............................. $ 90,402 $ 86,539 ========== ========== Net charge-offs to average loans (annualized) ......... 0.02% 0.05% ========== ========== Allowance for loan losses to loans outstanding ........ 1.15% 1.23% ========== ==========
The provision for loan losses for the first six months of 2005 totaled $1.5 million, a decrease of $1.0 million, or 40.0%, from the same period in 2004. Net charge-offs totaled $750,000, or 0.02% of average loans on an annualized basis, during the first six months of 2005, an $863,000 improvement over the $1.6 million, or 0.05%, in net charge-offs for the first six months of 2004. Non-performing assets decreased to $31.8 million, or 0.27% of total assets, at June 30, 2005, from $32.4 million, or 0.30% of total assets, at June 30, 2004. 127 Management believes that the allowance balance of $90.4 million at June 30, 2005 is sufficient to cover losses inherent in the loan portfolio on that date and is appropriate based on applicable accounting standards. Other Income The following table presents the components of other income:
SIX MONTHS ENDED JUNE 30 INCREASE (DECREASE) ----------------- ------------------- 2005 2004 $ % ------- ------- ------- ----- (dollars in thousands) Investment management and trust services .. $17,985 $17,282 $ 703 4.1% Service charges on deposit accounts ....... 19,292 19,434 (142) (0.7) Other service charges and fees ............ 12,698 9,996 2,702 27.0 Gain on sale of mortgage loans ............ 12,339 7,764 4,575 58.9 Investment securities gains ............... 4,733 11,177 (6,444) (57.7) Gain on sale of deposits .................. 2,201 -- 2,201 N/A Other ..................................... 4,920 3,047 1,873 61.5 ------- ------- ------- ----- Total .................................. $74,168 $68,700 $ 5,468 8.0% ======= ======= ======= =====
Total other income for the six months ended June 30, 2005 was $74.2 million, an increase of $5.5 million, or 8.0%, over the comparable period in 2004. Excluding investment securities gains, which decreased from $11.2 million in 2004 to $4.7 million in 2005, other income increased $11.9 million, or 20.7%. The Acquisitions contributed $7.1 million to this increase. Gains on sale of mortgage loans increased $4.6 million with the Acquisitions, mainly Resource Bank, contributing $4.1 million of the increase. Service charges on deposit accounts decreased $142,000, or 0.7%, (excluding the Acquisitions, service charges on deposit accounts decreased $681,000). The decrease was mainly due to increases in existing customers' balances resulting in lower service charges for those accounts. Other service charges and fees increased $2.7 million, or 27.0%, due mainly to a one-time increase in credit card merchant fee income and letter of credit fees. During the second quarter of 2005, the Corporation sold three branches and related deposits in two separate transactions. The sales resulted in $2.2 million of gains, primarily from the premiums paid on the deposits, which totaled $36.7 million. Other income increased $1.9 million, or 61.5%, with the Acquisitions accounting for $1.1 million of the increase and approximately $600,000 resulting from the change in the fair values of certain derivatives related to forward commitments for loan sales. Investment securities gains decreased $6.4 million, or 57.7%. These gains during the first six months of 2005 consisted of net realized gains of $3.9 million on the sale of equity securities and $845,000 on the sale of available-for-sale debt securities. Investment securities gains during the first six months of 2004 consisted of net realized gains of $8.1 million on the sale of equity securities and $3.1 million on the sale of available-for-sale debt securities. See the "Market Risk" section of Management's Discussion for information on the risks associated with the Corporation's portfolio of equity securities. 128 Other Expenses The following table presents the components of other expenses:
SIX MONTHS ENDED JUNE 30 INCREASE ------------------- -------------- 2005 2004 $ % -------- -------- ------- ---- (dollars in thousands) Salaries and employee benefits ... $ 89,532 $ 78,724 $10,808 13.7% Net occupancy expense ............ 14,047 11,377 2,670 23.5 Equipment expense ................ 5,958 5,390 568 10.5 Data processing .................. 6,490 5,687 803 14.1 Advertising ...................... 4,249 3,442 807 23.4 Intangible amortization .......... 2,347 2,347 -- -- Other ............................ 29,393 25,974 3,419 13.2 -------- -------- ------- ---- Total ......................... $152,016 $132,941 $19,075 14.3% ======== ======== ======= ====
Total other expenses increased $19.1 million, or 14.3%, in 2005, including $15.5 million due to the Acquisitions, as follows:
SIX MONTHS ENDED JUNE 30 ---------------- 2005 2004 INCREASE ------- ------ -------- (in thousands) Salaries and employee benefits ... $12,315 $4,472 $ 7,843 Net occupancy expense ............ 2,226 621 1,605 Equipment expense ................ 1,106 380 726 Data processing .................. 941 239 702 Advertising ...................... 546 173 373 Intangible amortization .......... 520 127 393 Other ............................ 5,536 1,656 3,880 ------- ------ ------- Total ......................... $23,190 $7,668 $15,522 ======= ====== =======
The following table presents the components of other expenses, excluding the amounts contributed by the Acquisitions:
SIX MONTHS ENDED INCREASE JUNE 30 (DECREASE) ------------------- -------------- 2005 2004 $ % -------- -------- ------ ----- (dollars in thousands) Salaries and employee benefits ... $ 77,217 $ 74,252 $2,965 4.0% Net occupancy expense ............ 11,821 10,756 1,065 9.9 Equipment expense ................ 4,852 5,010 (158) (3.2) Data processing .................. 5,549 5,448 101 1.9 Advertising ...................... 3,703 3,269 434 13.3 Intangible amortization .......... 1,827 2,220 (393) (17.7) Other ............................ 23,857 24,318 (461) (1.9) -------- -------- ------ ----- Total ......................... $128,826 $125,273 $3,553 2.8% ======== ======== ====== =====
129 The discussion that follows addresses changes in other expenses, excluding the Acquisitions. Salaries and employee benefits increased $3.0 million, or 4.0%, in comparison to the first six months of 2004. The salary expense component increased $1.9 million, or 3.2%, driven by salary increases for existing employees. Average full-time equivalent employees decreased from 2,906 in the first six months of 2004 to 2,891 in the first six months of 2005. Employee benefits increased $1.1 million, or 7.5%, in comparison to the first six months of 2004 driven mainly by continued increases in healthcare costs. Net occupancy expense increased $1.1 million, or 9.9%, to $11.8 million in 2005. The increase resulted from the expansion of the branch network and the addition of new office space for existing affiliates. Equipment expense decreased $158,000, or 3.2%, due to lower depreciation expense as certain equipment became fully depreciated. Data processing expense, which consists mainly of fees paid for outsourced back office systems, increased $101,000, or 1.9%. Advertising expense increased $434,000, or 13.3%, due to the timing of promotional campaigns. Intangible amortization decreased $393,000, or 17.7%, in the first six months of 2005. Intangible amortization consists of the amortization of unidentifiable intangible assets related to branch and loan acquisitions, core deposit intangible assets, and other identified intangible assets. Since many of these intangibles are amortized using accelerated methods, amortization expense of existing intangibles decreases over time. Other expense decreased $461,000, or 1.9%, mainly as a result of several non-recurring items, including a reduction of the reserve for legal contingencies. Income Taxes Income tax expense for the first six months of 2005 was $35.8 million, a $4.4 million, or 14.2%, increase from $31.3 million in 2004. The Corporation's effective tax rate was approximately 30.1% in 2005 as compared to 29.9% in 2004. The effective rate is lower than the Federal statutory rate of 35% due mainly to investments in tax-free municipal securities and federal tax credits from investments in low and moderate income housing partnerships. FINANCIAL CONDITION Total assets of the Corporation increased $412.7 million, or 3.7%, to $11.6 billion at June 30, 2005, compared to $11.2 billion at December 31, 2004. Increases occurred in loans ($277.0 million, or 3.7%), loans held for sale ($78.8 million, or 49.6%), and cash balances ($80.5 million, or 29.0%), while investment securities decreased modestly ($20.5 million, or 0.8%) and other earnings assets decreased $14.1 million. Commercial loans and mortgages grew $184.6 million, or 3.6%, during the six-month period, while residential mortgages increased $85.4 million, or 10.4%, mainly in construction loans. The increase in loans held for sale resulted from a continued decrease in residential mortgage rates during the period and an expansion of the Corporation's mortgage banking business. The $80.5 million increase in cash and due from banks was due to the nature of these accounts as daily balances can fluctuate up or down in the normal course of business. Deposits increased $244.1 million, or 3.1%, from December 31, 2004 to $8.1 billion. Noninterest-bearing deposits increased $104.1 million, or 6.9%, while interest-bearing demand deposits decreased $30.1. million, or 2.0%, and savings deposits increased $48.3 million, or 2.5%. Time deposits increased $121.8 million, or 4.1%, as rates have become more attractive to consumers. Short-term borrowings, which consist mainly of Federal funds purchased and customer cash management accounts, decreased $59.9 million, or 5.0%, during the first six months of 2005. The decrease in short-term borrowings was mainly 130 due to a decrease in Federal funds purchased, as funds from other sources including deposits and investment maturities, were sufficient to fund increases in loans. Long-term debt increased $267.5 million, or 39.1%, partially due to $100.0 million of subordinated debt issued in March 2005. See the "Liquidity" section of Management's Discussion for a summary of the terms of this debt. The remaining increase was mainly due to an increase in Federal Home Loan Bank Advances. The Corporation locked in longer-term rates in anticipation of increasing rates. As with the U.S. Treasury yields, longer-term FHLB rates have decreased over the last year. Capital Resources Total shareholders' equity decreased $48.3 million, or 3.9%, during the first six months of 2005. Increases due to net income of $83.0 million and $7.2 million in stock issuances were offset by $85.2 million in stock repurchases, $43.5 million in cash dividends to shareholders, $9.0 million in unrealized losses on securities, and $1.0 million in unrealized losses on derivative financial instruments. The Corporation periodically implements stock repurchase plans for various corporate purposes. In addition to evaluating the financial benefits of implementing repurchase plans, management also considers liquidity needs, the current market price per share and regulatory limitations. In December 2004, the Board of Directors approved an extension of an existing repurchase plan from December 31, 2004 to June 30, 2005 and increased the total number of shares that could be repurchased to 5.0 million. During the second quarter of 2005, the Corporation repurchased 4.3 million shares under an "accelerated share repurchase" plan (ASR), bringing the total shares purchased during the first six months of 2005 to 5.0 million and completing the board-approved repurchase plan. See Note L in the Notes to Consolidated Financial Statements for additional information on the ASR. The Corporation and its subsidiary banks are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain actions by regulators that could have a material effect on the Corporation's financial statements. The regulations require that banks maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk weighted assets (as defined), and Tier I capital to average assets (as defined). As of June 30, 2005, the Corporation and each of its bank subsidiaries met the minimum requirements. In addition, the Corporation and each of its bank subsidiaries' capital ratios exceeded the amounts required to be considered "well-capitalized" as defined in the regulations. The following table summarizes the Corporation's capital ratios in comparison to regulatory requirements as of June 30:
REGULATORY MINIMUM ---------------------- JUNE 30 DECEMBER 31 CAPITAL WELL 2005 2004 ADEQUACY CAPITALIZED ------- ----------- -------- ----------- Total Capital (to Risk Weighted Assets) ..... 12.4% 11.8% 8.0% 10.0% Tier I Capital to (Risk Weighted Assets) .... 10.1% 10.6% 4.0% 6.0% Tier I Capital (to Average Assets) .......... 7.7% 8.8% 3.0% 5.0%
Liquidity The Corporation must maintain a sufficient level of liquid assets to meet the cash needs of its customers, who, as depositors, may want to withdraw funds or who, as borrowers, need credit availability. Liquidity is provided on a continuous basis through scheduled and unscheduled principal and interest payments on outstanding loans and investments and through the availability of deposits and borrowings. In addition, the Corporation can borrow on a secured basis from the Federal Home Loan Bank to meet short-term liquidity needs. The Corporation's sources and uses of cash were discussed in general terms in the net interest income section of Management's Discussion. The Consolidated Statements of Cash Flows provide additional information. The Corporation generated $28.2 million in cash from operating activities during the first six months of 2005. Operating cash flows were 131 significantly lower than net income of $83.0 million, mainly due to cash outflows to fund loans originated for sale that had not yet been sold as of June 30, 2005. Investing activities resulted in a net cash outflow of $280.9 million, as purchases of investment securities and loan originations exceeded sales and maturities of investment securities. Finally, financing activities resulted in a net inflow of $333.3 million due to increases in both deposits and borrowings, offset by dividends paid to shareholders and repurchases of treasury stock. Liquidity must also be managed at the Fulton Financial Corporation Parent Company level. For safety and soundness reasons, banking regulations limit the amount of cash that can be transferred from subsidiary banks to the Parent Company in the form of loans and dividends. Generally, these limitations are based on the subsidiary banks' regulatory capital levels and their net income. Until 2004, the Parent Company had been able to meet its cash needs through normal, allowable dividends and loans. However, as a result of increased acquisition activity and stock repurchase plans, the Parent Company's cash needs have increased, requiring additional sources of funds. In July 2004, the Parent Company entered into a revolving line of credit agreement with an unaffiliated bank. Under the terms of the agreement, the Parent Company can borrow up to $50.0 million (which may be increased to $100.0 million upon request) with interest calculated at the one-month London Interbank Offering Rate (LIBOR) plus 0.625%. The credit agreement requires the Corporation to maintain certain financial ratios related to capital strength and earnings. At June 30, 2005, the Corporation had borrowed $20.0 million on the line and was in compliance with all covenants under the credit agreement. In March 2005, the Parent Company issued $100 million of ten year subordinated notes at a fixed rate of 5.35%. Interest is paid semi-annually, beginning in October 2005 and the notes mature on April 1, 2015. In addition to providing funds to the Parent Company, this subordinated debt is also a component of total regulatory capital. These borrowing arrangements supplement the liquidity available from subsidiaries through dividends and borrowings and provide some flexibility in Parent Company cash management. Management continues to monitor the liquidity and capital needs of the Parent Company and will implement appropriate strategies, as necessary, to remain well capitalized and to meet its cash needs. In addition to its normal recurring and operating cash needs, the Parent Company paid approximately $20.7 million in cash on July 1, 2005 for a portion of the SVB acquisition. See Note I, "Subsequent Events" in the Notes to Consolidated Financial Statements for a summary of the terms of this transaction. 132 ~~-----END PRIVACY-ENHANCED MESSAGE-----~~