Capitol Bancorp (CBCRQ) 10-Q 2005 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005

OR

o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from                    to                    

Commission file number001-31708

CAPITOL BANCORP LTD.

(Exact name of registrant as specified in its charter)

Michigan
(State or other jurisdiction
of incorporation or
organization) 38-2761672
(I.R.S. Employer
Identification
Number)

Capitol Bancorp Center
200 Washington Square North, Lansing, Michigan
(Address of principal executive offices)
48933
(Zip Code)
(517) 487-6555
(Registrant’s telephone number)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

     Indicate by a check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yesþ Noo

APPLICABLE ONLY TO CORPORATE ISSUERS:

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

     Indicate by a check mark whether the registrant is shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

     Common stock, No par value: 15,231,233 shares outstanding as of October 15, 2005.

Page 1 of 29

INDEX

PART I. FINANCIAL INFORMATION

Forward-Looking Statements

Certain of the statements contained in this document, including Capitol’s consolidated financial statements, Management’s Discussion and Analysis of Financial Condition and Results of Operations and in documents incorporated into this document by reference that are not historical facts, including, without limitation, statements of future expectations, projections of results of operations and financial condition, statements of future economic performance and other forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, are subject to known and unknown risks, uncertainties and other factors which may cause the actual future results, performance or achievements of Capitol and/or its subsidiaries and other operating units to differ materially from those contemplated in such forward-looking statements. The words “intend,” “expect,” “project,” “estimate,” “predict,” “anticipate,” “should,” “believe,” and similar expressions also are intended to identify forward-looking statements. Important factors which may cause actual results to differ from those contemplated in such forward-looking statements include, but are not limited to: (i) the results of Capitol’s efforts to implement its business strategy, (ii) changes in interest rates, (iii) legislation or regulatory requirements adversely impacting Capitol’s banking business and/or expansion strategy, (iv) adverse changes in business conditions or inflation, (v) general economic conditions, either nationally or regionally, which are less favorable than expected and that result in, among other things, a deterioration in credit quality and/or loan performance and collectability, (vi) competitive pressures among financial institutions, (vii) changes in securities markets, (viii) actions of competitors of Capitol’s banks and Capitol’s ability to respond to such actions, (ix) the cost of capital, which may depend in part on Capitol’s asset quality, prospects and outlook, (x) changes in governmental regulation, tax rates and similar matters, and (xi) other risks detailed in Capitol’s other filings with the Securities and Exchange Commission. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated. All subsequent written or oral forward-looking statements attributable to Capitol or persons acting on its behalf are expressly qualified in their entirety by the foregoing factors. Investors and other interested parties are cautioned not to place undue reliance on such statements, which speak as of the date of such statements. Capitol undertakes no obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of unanticipated events.

	Page
Item 1. Financial Statements (unaudited):
Condensed consolidated balance sheets — September 30, 2005 and December 31, 2004.		3
Condensed consolidated statements of income — Three months and nine months ended September 30, 2005 and 2004.		4
Condensed consolidated statements of changes in stockholders’ equity — Nine months ended September 30, 2005 and 2004.		5
Condensed consolidated statements of cash flows — Nine months ended September 30, 2005 and 2004.		6
Notes to condensed consolidated financial statements.		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.		13
Item 3. Quantitative and Qualitative Disclosures About Market Risk.		25
Item 4. Controls and Procedures.		25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.		26
Item 2. Unregistered Sales of Securities and Use of Proceeds.		26
Item 3. Defaults Upon Senior Securities.		26
Item 4. Submission of Matters to a Vote of Security Holders.		26
Item 5. Other Information.		26
Item 6. Exhibits and Reports on Form 8-K.		26
SIGNATURES		28
EXHIBIT INDEX		29
Certification of Chief Executive Officer, Joseph D. Reid, pursuant to Section 302
Certification of Chief Financial Officer, Lee W. Hendrickson, pursuant to Section 302
Certification of Chief Executive Officer, Joseph D. Reid, pursuant to Section 906
Certification of Chief Financial Officer, Lee W. Hendrickson, pursuant to Section 906

Page 2 of 29

PART I, ITEM I

CAPITOL BANCORP LTD.

Condensed Consolidated Balance Sheets

As of September 30, 2005 and December 31, 2004

		(Unaudited)
		September 30			December 31
	��	2005			2004
		(in thousands)
ASSETS
Cash and due from banks		$	165,613		$	123,969
Money market and interest-bearing deposits			22,538			10,745
Federal funds sold			191,673			96,390
Cash and cash equivalents			379,824			231,104
Loans held for resale			33,632			43,143
Investment securities:
Available for sale, carried at market value			29,177			28,172
Held for long-term investment, carried at amortized cost which approximates market value			16,422			14,191
Total investment securities			45,599			42,363
Portfolio loans:
Commercial			2,590,153			2,444,492
Real estate mortgage			216,288			177,204
Installment			82,125			71,208
Total portfolio loans			2,888,566			2,692,904
Less allowance for loan losses			(39,284	)		(37,572	)
Net portfolio loans			2,849,282			2,655,332
Premises and equipment			33,257			32,661
Accrued interest income			12,043			10,447
Goodwill and other intangibles			44,928			41,943
Other assets			47,764			34,425
TOTAL ASSETS		$	3,446,329		$	3,091,418
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Noninterest-bearing		$	622,897		$	503,902
Interest-bearing			2,176,546			2,006,170
Total deposits			2,799,443			2,510,072
Debt obligations:
Notes payable and short-term borrowings			173,823			172,534
Subordinated debentures			100,916			100,845
Total debt obligations			274,739			273,379
Accrued interest on deposits and other liabilities			21,778			16,288
Total liabilities			3,095,960			2,799,739
MINORITY INTERESTS IN CONSOLIDATED SUBSIDIARIES			70,135			39,520
STOCKHOLDERS’ EQUITY:
Common stock, no par value, 50,000,000 shares authorized;
issued and outstanding: 2005 - 15,223,775 shares
2004 - 14,828,750 shares			205,628			196,271
Retained earnings			78,428			60,476
Market value adjustment (net of tax effect) for investment securities available for sale (accumulated other comprehensive income)			(185	)		(36	)
			283,871			256,711
Less unearned compensation regarding restricted stock and other			(3,637	)		(4,552	)
Total stockholders’ equity			280,234			252,159
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	3,446,329		$	3,091,418

Page 3 of 29

CAPITOL BANCORP LIMITED

Condensed Consolidated Statements of Income (Unaudited)

For the Three Months and Nine Months Ended September 30, 2005 and 2004

(in thousands, except per share data)

	Periods Ended September 30
	Three Month Period					Nine Month Period
	2005		2004			2005		2004
Interest income:
Portfolio loans (including fees)	$	55,886	$	44,492		$	156,470	$	126,560
Loans held for resale		741		504			2,014		1,529
Taxable investment securities		222		275			741		1,071
Federal funds sold		1,506		407			3,059		1,053
Other		300		199			783		547
Total interest income		58,655		45,877			163,067		130,760
Interest expense:
Deposits		14,188		9,176			37,231		26,891
Debt obligations and other		3,626		2,767			10,600		7,757
Total interest expense		17,814		11,943			47,831		34,648
Net interest income		40,841		33,934			115,236		96,112
Provision for loan losses		2,107		3,553			7,169		9,597
Net interest income after provision for loan losses		38,734		30,381			108,067		86,515
Noninterest income:
Service charges on deposit accounts		1,062		1,091			3,115		3,336
Trust fee income		526		796			1,654		2,535
Fees from origination of non-portfolio residential mortgage loans		1,820		1,314			4,590		4,211
Realized gains (losses) on sale of investment securities available for sale		6		(191	)		8		(424	)
Other		1,524		1,531			5,768		4,777
Total noninterest income		4,938		4,541			15,135		14,435
Noninterest expense:
Salaries and employee benefits		19,416		14,493			54,768		46,082
Occupancy		2,483		2,173			7,170		6,428
Equipment rent, depreciation and maintenance		1,571		1,325			4,593		4,266
Other		6,844		5,778			18,952		14,917
Total noninterest expense		30,314		23,769			85,483		71,693
Income before income taxes and minority interest		13,358		11,153			37,719		29,257
Income taxes		5,195		4,274			14,518		11,301
Income before minority interest		8,163		6,879			23,201		17,956
Minority interest in net losses of consolidated subsidiaries		1,431		560			2,705		810
NET INCOME	$	9,594	$	7,439		$	25,906	$	18,766
NET INCOME PER SHARE
Basic	$	0.64	$	0.52		$	1.75	$	1.33
Diluted	$	0.61	$	0.50		$	1.67	$	1.27

Page 4 of 29

CAPITOL BANCORP LIMITED

Condensed Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
For the Nine Months Ended September 30, 2005 and 2004
(in thousands except share data)

									Unearned
						Accumulated			Compensation
						Other			Regarding
	Common		Retained			Comprehensive			Restricted Stock
	Stock		Earnings			Income			and Other			Total
Nine Months Ended September 30, 2004
Balances at January 1, 2004	$	180,957	$	43,135		$	(200	)	$	(4,995	)	$	218,897
Issuance of 183,349 shares of common stock in conjunction with acquisition of bank		4,970											4,970
Issuance of 346,947 shares of common stock to acquire minority interest in subsidiaries		8,665											8,665
Issuance of 167,550 shares of common stock upon exercise of stock options, net of common stock surrendered to facilitate exercise		356											356
Issuance of 13,063 shares of restricted common stock		377								(377	)		0
Recognition of compensation expense relating to restricted common stock										968			968
Cash dividends paid ($0.48 per share)				(6,863	)								(6,863	)
Components of comprehensive income:
Net income for the period				18,766									18,766
Market value adjustment for investment securities available for sale (net of income tax effect)							251						251
Comprehensive income for the period													19,017
BALANCES AT SEPTEMBER 30, 2004	$	195,325	$	55,038		$	51		$	(4,404	)	$	246,010
Nine Months Ended September 30, 2005
Balances at January 1, 2005	$	196,271	$	60,476		$	(36	)	$	(4,552	)	$	252,159
Issuance of 201,731 shares of common stock to acquire portion of minority interest in subsidiary		6,377											6,377
Issuance of 193,294 shares of common stock upon exercise of stock options, net of common stock surrendered to facilitate exercise		2,980											2,980
Recognition of compensation expense relating to restricted common stock										915			915
Cash dividends paid ($0.53 per share)				(7,954	)								(7,954	)
Components of comprehensive income:
Net income for the period				25,906									25,906
Market value adjustment for investment securities available for sale (net of income tax effect)							(149	)					(149	)
Comprehensive income for the period													25,757
BALANCES AT SEPTEMBER 30, 2005	$	205,628	$	78,428		$	(185	)	$	(3,637	)	$	280,234

Page 5 of 29

CAPITOL BANCORP LTD.

Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2005 and 2004

	2005			2004
	(in thousands)
OPERATING ACTIVITIES
Net income	$	25,906		$	18,766
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		7,169			9,597
Depreciation of premises and equipment		4,179			3,520
Amortization of intangibles		431			410
Net amortization of investment security premiums		63			19
Loss on sale of premises and equipment		14			1
Minority interest in net losses of consolidated subsidiaries		(2,705	)		(810	)
Compensation expense relating to restricted common stock		915			968
Originations and purchases of loans held for resale		(500,957	)		(558,147	)
Proceeds from sales of loans held for resale		510,468			565,950
Increase in accrued interest income and other assets		(17,568	)		(6,526	)
Increase in accrued interest expense on deposits and other liabilities		5,490			835
NET CASH PROVIDED BY OPERATING ACTIVITIES		33,405			34,583
INVESTING ACTIVITIES
Cash and cash equivalents of acquired subsidiary		1,357			4,202
Proceeds from sale of investment securities available for sale		1,757			68,302
Proceeds from calls, prepayments and maturities of investment securities		6,279			5,098
Purchases of investment securities		(11,561	)		(18,451	)
Net increase in portfolio loans		(201,119	)		(316,590	)
Proceeds from sales of premises and equipment		83			22
Purchases of premises and equipment		(4,872	)		(8,846	)
NET CASH USED BY INVESTING ACTIVITIES		(208,076	)		(266,263	)
FINANCING ACTIVITIES
Net increase in demand deposits, NOW accounts and savings accounts		146,955			172,176
Net increase in certificates of deposit		142,416			2,722
Net borrowings from debt obligations		1,289			43,322
Net proceeds from issuance of subordinated debentures		—			9,935
Resources provided by minority interests		37,705			14,761
Net proceeds from issuance of common stock		2,980			356
Cash dividends paid		(7,954	)		(6,863	)
NET CASH PROVIDED BY FINANCING ACTIVITIES		323,391			236,409
INCREASE IN CASH AND CASH EQUIVALENTS		148,720			4,729
Cash and cash equivalents at beginning of period		231,104			283,623
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	379,824		$	288,352

Page 6 of 29

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD.

Note A — Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements of Capitol Bancorp Ltd. (“Capitol”) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q. Accordingly, they do not include all information and footnotes necessary for a fair presentation of consolidated financial position, results of operations and cash flows in conformity with generally accepted accounting principles.

     The statements do, however, include all adjustments of a normal recurring nature (in accordance with Rule 10-01(b)(8) of Regulation S-X) which Capitol considers necessary for a fair presentation of the interim periods.

     The results of operations for the period ended September 30, 2005 are not necessarily indicative of the results to be expected for the year ending December 31, 2005.

     The consolidated balance sheet as of December 31, 2004 was derived from audited consolidated financial statements as of that date. Certain 2004 amounts have been reclassified to conform to the 2005 presentation.

Note B — Implementation of New Accounting Standard

     AICPA Statement of Position 03-3,Accounting for Certain Loans or Debt Securities Acquired in a Transfer(SOP 03-3), addresses the accounting for differences between contractual cash flows and cash flows expected to be collected from the initial investment in loans acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes such loans acquired in purchase business combinations and does not apply to loans originated by the entity. The SOP prohibits carrying over or creation of valuation allowances in the initial accounting for loans acquired in a transfer. It is effective for loans acquired in fiscal years beginning after December 15, 2004. This new guidance had no significant effect on Capitol’s consolidated financial statements upon implementation.

[The remainder of this page intentionally left blank]

Page 7 of 29

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. — Continued

Note C — Stock Options

     Statement of Financial Accounting Standards No. 123,Accounting for Stock-Based Compensation, establishes an alternative fair value method of accounting for stock options whereby compensation expense would be recognized based on the computed fair value of the options on the grant date. By not electing this alternative, certain pro forma disclosures of the expense recognition provisions of Statement No. 123 are required, which are as follows:

	Periods Ended September 30
	Three Month Period					Nine Month Period
	2005		2004			2005			2004
Fair value assumptions:
Risk-free interest rate				3.9	%		4.1	%		3.8	%
Dividend yield				2.5	%		2.2	%		2.3	%
Stock price volatility				.22			.27			.26
Expected option life			7 years			7 years			6.5 years
Aggregate estimated fair value of options granted (in thousands)	$	—	$	1,074		$	4,781		$	4,275
Net income (in thousands):
As reported	$	9,594	$	7,439		$	25,906		$	18,766
Less pro forma compensation expense regarding fair value of stock option awards, net of related income tax effect		—		(698	)		(3,108	)		(2,779	)
Pro forma	$	9,594	$	6,741		$	22,798		$	15,987
Net income per share:
Basic:
As reported	$	0.64	$	0.52		$	1.75		$	1.33
Pro forma		0.64		0.47			1.54			1.14
Diluted:
As reported		0.61		0.50			1.67			1.27
Pro forma	$	0.61	$	0.45		$	1.47		$	1.08

     Stock option activity for the interim 2005 period is summarized as follows:

						Weighted
	Number of			Exercise		Average
	Stock Options			Price		Exercise
	Outstanding			Range		Price
Outstanding at January 1		2,584,139		$	10.81 to $33.01	$	21.06
Exercised		(312,042	)		11.00 to 30.21		16.51
Granted		533,327			30.21 to 34.84		31.60
Cancelled or expired		(41,337	)		23.24 to 29.10
Outstanding at September 30		2,764,087		$	10.81 to $34.84	$	23.57

Page 8 of 29

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. — Continued

Note C — Stock Options – Continued

     As of September 30, 2005, stock options outstanding had a weighted average remaining contractual life of 4.3 years. The following table summarizes stock options outstanding segregated by exercise price range:

			Weighted Average
					Remaining
Exercise Price	Number		Exercise		Contractual
Range	Outstanding		Price		Life
$10.00 to 14.99		304,441	$	11.34	1.8 years
$15.00 to 19.99		531,784		16.67	3.3 years
$20.00 to 24.99		498,056		21.72	4.3 years
$25.00 to 29.99		738,703		27.03	4.6 years
$30.00 or more		691,103	$	31.92	6.0 years
Total outstanding		2,764,087

Note D — Net Income Per Share

     The computations of basic and diluted earnings per share were as follows:

	Periods Ended September 30
	Three Month Period				Nine Month Period
	2005		2004		2005		2004
Numerator—net income for the period	$	9,594,000	$	7,439,000	$	25,906,000	$	18,766,000
Denominator:
Weighted average number of common shares outstanding, excluding unvested shares of restricted common stock (denominator for basic earnings per share)		14,939,912		14,311,842		14,776,778		14,069,446
Weighted average number of unvested shares of restricted common stock outstanding		201,990		259,300		208,384		263,869
Effect of other dilutive securities (stock options)		537,597		422,391		485,855		426,651
Denominator for diluted net income per share—
Weighted average number of common shares and potential dilution		15,679,499		14,993,533		15,471,017		14,759,966
Number of antidilutive stock options excluded from diluted earnings per share computation		—		—		—		—

Page 9 of 29

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. — Continued

Note E — New Banks and Bank Development Activities

     Bank of Michigan, located in Farmington Hills, Michigan, opened in January 2005. During June 2005, the following banks opened: Bank of Bellevue, located in Bellevue, Washington, and Fort Collins Commerce Bank, located in Fort Collins, Colorado. In early July 2005, Bank of Auburn Hills opened in Auburn Hills, Michigan. In early August 2005, Bank of San Francisco opened in San Francisco, California. These banks are majority-owned by Capitol or bank-development subsidiaries controlled by Capitol.

     In 2005, Capitol Development Bancorp Limited III was capitalized as a controlled subsidiary of Capitol, with approximately $16 million (including approximately $15 million provided by minority interests) to fund future bank development activity.

     Bank development efforts were in process at September 30, 2005 in several states pending approvals from regulatory agencies, including pre-development exploratory discussions, lease and employment negotiations and preparation of preliminary regulatory applications for formation and/or acquisition of community banks. At September 30, 2005, Capitol had applications pending for additionalde novocommunity banks in Arizona, California, Georgia, Illinois, Missouri and North Carolina.

Note F — Share Exchange Transaction

     A share exchange offer transaction regarding Napa Community Bank was completed effective August 31, 2005. Shares acquired from the Bank’s shareholders accepting Capitol’s exchange offer were exchanged for Capitol’s common stock according to an exchange ratio. In total, Capitol issued approximately 202,000 shares of previously unissued common stock resulting from this transaction (for consideration approximating $6.4 million), increasing Capitol’s ownership of Napa Community Bank to approximately 87%. This acquisition of minority interests was recorded using the purchase-method of accounting. The pro forma effect of this transaction was not significant.

Note G — Acquisition of Bank

     In April 2005, Capitol acquired a majority interest in Peoples State Bank (“Peoples”) located in Jeffersonville, Georgia, in a purchase transaction with total consideration approximating $2.2 million. Peoples’ total assets approximated $22.9 million at the acquisition date, including $1.2 million of goodwill relating to the purchase of the controlling interest in the bank by Capitol. Capitol’s acquisition of Peoples was accounted for under the purchase method of accounting and its results of operations are included in Capitol’s consolidated financial statements for periods after the effective date of the acquisition. The pro forma effect of this acquisition was not significant.

Page 10 of 29

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. — Continued

Note H — Impact of New Accounting Standards

     In December 2004, the Financial Accounting Standards Board (“FASB”) issued a revision of Statement No. 123. Statement No. 123(R),Share-Based Payment, is broader in scope than the original statement, which was more narrowly focused on stock-based compensation, and makes significant changes to accounting for “payments” involving employee compensation and “shares” or securities, in the form of stock options, restricted stock or other arrangements settled in the reporting entity’s securities. Most significant in the standard is the requirement that all stock options be measured at estimated fair value at the grant date and recorded as compensation expense over the requisite service period associated with the option, usually the vesting period. The revised standard was to become effective for interim periods beginning after June 30, 2005 and be applied prospectively to stock options granted after the effective date and any unvested stock options at that date; however, the SEC superseded the FASB’s implementation timetable in April 2005, changing the effective date to the beginning of 2006 for calendar-year public companies.

     Although Capitol’s management has not completed its analysis of the revised standard, the effect of the revised standard’s implementation will be recognition of compensation expense associated with stock options. Previously, Capitol has used the intrinsic-value method which did not result in expense recognition but, instead, required pro forma presentation of what compensation expense would have been recorded if the fair-value measurement and expense recognition provisions had been applied. Effective December 31, 2004, Capitol accelerated the vesting of all of its outstanding stock options in anticipation of implementation of Statement No. 123(R). Such acceleration of vesting, to make all such stock options vested as of December 31, 2004, was done for the purpose of avoiding future expense associated with any unvested stock options granted prior to the effective date of Statement No. 123(R). All stock options granted during the interim periods of 2005 vested at the grant date. As mentioned above, the current accounting standard in effect prior to the effective date of Statement No. 123(R) requires disclosure of what pro forma compensation expense would have been if stock options granted had been recorded at fair value using measurement techniques which are similar to those prescribed in Statement No. 123(R); such disclosures appear in Note C. That presentation should not be viewed as an estimate of future expense levels inasmuch as it is based on stock options granted in the periods presented which may differ significantly from future granting activity, assumptions used and the structure of share-based payment awards.

     FASB’s Emerging Issues Task Force (“EITF”), reached consensus on “The Meaning of Other-Than-Temporary and Its Application to Certain Investments” in EITF Issue No. 03-1. The guidance included in the EITF consensus largely consisted of expanded disclosures and the guidance was intended to be fully effective in 2003, except for loss-recognition guidance which had a delayed effective date into 2004. In 2004, the FASB has further delayed the loss recognition provisions of Issue No. 03-1. In June 2005, the FASB announced plans to supersede the EITF guidance with a revised standard in late 2005. Because of the inconclusive status of the guidance on the loss recognition aspects of Issue No. 03-1, Capitol’s management is unable to speculate on the potential impact of this matter on Capitol’s consolidated financial statements.

Page 11 of 29

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPITOL BANCORP LTD. — Continued

Note H — Impact of New Accounting Standards — Continued

     Most recently, the FASB has issued several proposals to amend, supersede or interpret existing accounting standards which may impact Capitol’s financial statements at a later date:

• Proposed amendment to Statement No. 128,Earnings per Share.

• Proposed amendments to Statement No. 140,Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.

• Proposed interpretation regardingUncertain Tax Positions.

• Proposed replacement of Statement No. 141 regardingBusiness Combinations.

• Proposed replacement of Accounting Research Bulletin No. 51 regardingConsolidated Financial Statements, Including Accounting and Reporting for Noncontrolling Interests.

     Due to the uncertain future status of these proposals, Capitol’s management is unable to estimate their potential impact on Capitol’s consolidated financial statements.

     A variety of other proposed or otherwise potential accounting standards are currently under study by standard-setting organizations and various regulatory agencies. Because of the tentative and preliminary nature of these proposed standards, management has not determined whether implementation of such proposed standards would be material to Capitol’s consolidated financial statements.

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Page 12 of 29

PART I, ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

Financial Condition

     Total assets approximated $3.4 billion at September 30, 2005, an increase of $355 million from the December 31, 2004 level of $3.1 billion. The balance sheet includes Capitol and its consolidated subsidiaries:

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Page 13 of 29

	Total Assets (in $1,000’s)
	Sept 30, 2005			Dec 31, 2004
Eastern Regions:
Great Lakes Region:
Ann Arbor Commerce Bank	$	328,524		$	330,488
Bank of Auburn Hills(5)		9,259			n/a
Bank of Michigan(1)		17,161			n/a
Brighton Commerce Bank		102,264			105,890
Capitol National Bank		244,760			228,656
Detroit Commerce Bank		82,418			70,036
Elkhart Community Bank		78,946			67,099
Goshen Community Bank		63,290			54,571
Grand Haven Bank		120,678			119,254
Kent Commerce Bank		85,120			89,393
Macomb Community Bank		88,363			94,847
Muskegon Commerce Bank		98,001			94,162
Oakland Commerce Bank		123,321			130,779
Paragon Bank & Trust		111,297			110,128
Portage Commerce Bank		188,082			180,817
Great Lakes Region Total		1,741,484			1,676,120
Southeast Region:
First Carolina State Bank		77,968			68,598
Peoples State Bank(2)		28,711			n/a
Southeast Region Total		106,679			68,598
Eastern Regions Total		1,848,163			1,744,718
Western Regions:
Southwest Region:
Arrowhead Community Bank		81,549			70,989
Bank of Las Vegas		75,162			47,538
Bank of Tucson		193,813			168,469
Black Mountain Community Bank		122,606			100,415
Camelback Community Bank		87,250			83,414
Desert Community Bank		81,141			63,276
East Valley Community Bank		45,881			46,549
Fort Collins Commerce Bank(3)		18,571			n/a
Mesa Bank		124,181			96,158
Red Rock Community Bank		116,688			102,832
Southern Arizona Community Bank		91,409			83,140
Sunrise Bank of Albuquerque		67,868			69,055
Sunrise Bank of Arizona		114,346			128,192
Valley First Community Bank		75,378			54,857
Yuma Community Bank		58,868			59,355
Southwest Region Total		1,354,711			1,174,239
California Region:
Bank of Escondido		67,757			50,956
Bank of San Francisco(6)		12,650			n/a
Napa Community Bank		78,680			79,396
Point Loma Community Bank		35,142			20,857
Sunrise Bank of San Diego		64,856			62,672
California Region Total		259,085			213,881
Northwest Region — Bank of Bellevue(4)		13,568			n/a
Western Regions Total		1,627,364			1,388,120
Other, net		(29,198	)		(41,420	)
Consolidated	$	3,446,329		$	3,091,418

n/a — Not applicable.
(1)	Commenced operations in January 2005 and is 51%-owned by Capitol Development Bancorp Limited I, a controlled subsidiary of Capitol.
(2)	Acquired in April 2005 and is 62%-owned by Capitol.
(3)	Commenced operations in June 2005 and is 51%-owned by Capitol Bancorp Colorado Limited, a wholly-owned subsidiary of Capitol.
(4)	Commenced operations in June 2005 and is 51%-owned by Capitol Development Bancorp Limited II, a controlled subsidiary of Capitol.
(5)	Commenced operations in July 2005 and is 51%-owned by Capitol Development Bancorp Limited II, a controlled subsidiary of Capitol.
(6)	Commenced operations in August 2005 and is 51%-owned by Capitol.

Page 14 of 29

     Portfolio loans increased during the nine-month 2005 period by approximately $196 million, compared to net loan growth of about $361 million during the corresponding period of 2004. Year-to-date loan growth includes the acquisition of Peoples State Bank, effective April 1, 2005, which had portfolio loans totaling approximately $13 million at the acquisition date. Loan growth in the first quarter of 2005 approximated $67 million ($100 million in 2004). Second and third quarter 2005 loan growth approximated $84 million and $45 million, respectively, compared to $113 million and $97 million in 2004. 2005 loan growth for the nine-month period has been lower than 2004 levels due to softening loan demand. The majority of portfolio loan growth occurred in commercial loans, consistent with the banks’ emphasis on commercial lending activities.

     The allowance for loan losses at September 30, 2005 approximated $39 million or 1.36% of total portfolio loans, which was slightly lower than the mid-year level of 1.37% and year-end 2004 ratio of 1.40%. The interim 2005 decrease in the allowance ratio is consistent with improvements in asset quality during the period.

     The allowance for loan losses is maintained at a level believed adequate by management to absorb potential losses inherent in the loan portfolio at the balance sheet date. Management’s determination of the adequacy of the allowance is based on evaluation of the portfolio (including potential impairment of individual loans and concentrations of credit), past loss experience, current economic conditions, volume, amount and composition of the loan portfolio and other factors. The allowance is increased by provisions charged to operations and reduced by net charge-offs. The table below summarizes portfolio loan balances and activity in the allowance for loan losses for the interim periods (in thousands):

	Periods Ended September 30
	Three Month Period						Nine Month Period
	2005			2004			2005			2004
Allowance for loan losses at beginning of period	$	38,870		$	35,137		$	37,572		$	31,404
Allowance for loan losses of acquired bank subsidiary		—			—			—			724
Loans charged-off:
Commercial		(2,304	)		(1,673	)		(6,541	)		(5,142	)
Real estate mortgage		—			(17	)		—			(116	)
Installment		(129	)		(108	)		(440	)		(248	)
Total charge-offs		(2,433	)		(1,798	)		(6,981	)		(5,506	)
Recoveries:
Commercial		709			129			1,426			761
Real estate mortgage		1			—			2			10
Installment		30			6			96			37
Total recoveries		740			135			1,524			808
Net charge-offs		(1,693	)		(1,663	)		(5,457	)		(4,698	)
Additions to allowance charged to expense		2,107			3,553			7,169			9,597
Allowance for loan losses at September 30	$	39,284		$	37,027		$	39,284		$	37,027
Average total portfolio loans for the period	$	2,868,354		$	2,566,005		$	2,804,285		$	2,437,698
Ratio of net charge-offs (annualized) to average portfolio loans outstanding		0.24	%		0.26	%		0.26	%		0.26	%

 Page 15 of 29

     Net charge-offs of loans in the nine-month 2005 period increased by approximately $759,000, compared to the corresponding 2004 period. The increase was mainly due to charge-offs associated with commercial loans ($1.4 million), while the amount of recoveries increased $716,000 during the 2005 period.

     The amounts of the allowance for loan losses allocated in the following table (in thousands) are based on management’s estimate of losses inherent in the portfolio at the balance-sheet date, include all loans for which, based on Capitol’s loan rating system, management has concerns, and should not be interpreted as an indication of future charge-offs.

	September 30, 2005					December 31, 2004
			Percentage					Percentage
			of Total					of Total
			Portfolio					Portfolio
	Amount		Loans			Amount		Loans
Commercial	$	36,420		1.26	%	$	34,753		1.29	%
Real estate mortgage		1,701		0.06			1,808		0.07
Installment		1,163		0.04			1,011		0.04
Total allowance for loan losses	$	39,284		1.36	%	$	37,572		1.40	%
Total portfolio loans outstanding	$	2,888,566				$	2,692,904

     Nonperforming loans (i.e., loans which are 90 days or more past due and loans on nonaccrual status) and other nonperforming assets are summarized below (in thousands):

	Sept 30,		Dec 31,
	2005		2004
Nonaccrual loans:
Commercial	$	18,028	$	20,618
Real estate mortgage		1,562		2,396
Installment		925		195
Total nonaccrual loans		20,515		23,209
Past due (³90 days) loans:
Commercial		4,061		3,529
Real estate mortgage		465		1,382
Installment		194		351
Total past due loans		4,720		5,262
Total nonperforming loans	$	25,235	$	28,471
Real estate owned and other repossessed assets		2,938		3,907
Total nonperforming assets	$	28,173	$	32,378

 Page 16 of 29

     Nonperforming loans decreased 11% or $3.2 million during the nine-month period ended September 30, 2005. Nonperforming loans at September 30, 2005 were 0.87% of total portfolio loans, a significant improvement from the ratio of 1.10% at September 30, 2004. Of the nonperforming loans at September 30, 2005, about 71% were real estate secured. Those loans, when originated, had appropriate loan-to-value ratios and, accordingly, have loss exposure which is expected to be minimal; however, underlying real estate values depend upon current economic conditions and liquidation strategies. Most other nonperforming loans were generally secured by other business assets. Nonperforming loans at September 30, 2005 were in various stages of resolution for which management believes such loans are adequately collateralized or otherwise appropriately considered in its determination of the adequacy of the allowance for loan losses.

     In addition to the identification of nonperforming loans involving borrowers with payment performance difficulties (i.e., nonaccrual loans and loans past-due 90 days or more), management utilizes an internal loan review process to identify other potential problem loans which may warrant additional monitoring or other attention. This loan review process is a continuous activity which periodically updates internal loan ratings. At inception, all loans are individually assigned a rating which grades the credits on a risk basis, based on the type and discounted value of collateral, financial strength of the borrower and guarantors and other factors such as the nature of the borrower’s business climate, local economic conditions and other subjective factors. The loan rating process is fluid and subjective.

     Potential problem loans include loans which are generally performing as agreed; however, because of internal loan review and/or lending staff risk assessment, increased monitoring is deemed appropriate. In addition, some loans are assigned a more adverse classification, with specific performance issues or other risk factors requiring close management and development of specific remedial action plans.

     At September 30, 2005, potential problem loans (including the previously mentioned nonperforming loans) approximated $115 million, or about 4% of total consolidated portfolio loans. These potential problem loans do not necessarily have significant loss exposure (nor are they necessarily deemed ‘impaired’), but rather are identified by management in this manner to aid in loan administration and risk management. Management believes such loans to be adequately considered in its evaluation of the adequacy of the allowance for loan losses. Management believes, however, that current general economic conditions are uncertain and could result in higher levels of future loan losses in comparison to previous years.

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 Page 17 of 29

     The following comparative analysis summarizes each bank’s total portfolio loans, allowance for loan losses, nonperforming loans and ratio of the allowance as a percentage of portfolio loans (dollars in thousands):

	Total				Allowance for				Nonperforming				Allowance as a Percentage
	Portfolio Loans				Loan Losses				Loans				of Total Portfolio Loans
	Sept 30		Dec 31		Sept 30		Dec 31		Sept 30		Dec 31		Sept 30			Dec 31
	2005		2004		2005		2004		2005		2004		2005			2004
Eastern Regions:
Great Lakes Region:
Ann Arbor Commerce Bank	$	297,596	$	297,936	$	4,203	$	3,907	$	3,415	$	2,460		1.41	%		1.31	%
Bank of Auburn Hills(5)		2,665		n/a		38		n/a		—		n/a		1.43			n/a
Bank of Michigan(1)		10,934		n/a		164		n/a		—		n/a		1.50			n/a
Brighton Commerce Bank		92,739		95,408		977		969		1,398		1,035		1.05			1.02
Capitol National Bank		196,481		196,519		2,710		2,723		1,508		2,053		1.38			1.39
Detroit Commerce Bank		79,338		66,280		1,012		806		274		338		1.28			1.22
Elkhart Community Bank		72,868		63,987		838		712		814		277		1.15			1.11
Goshen Community Bank		53,211		48,059		608		644		—		703		1.14			1.34
Grand Haven Bank		113,303		109,612		2,449		2,522		3,309		7,264		2.16			2.30
Kent Commerce Bank		75,348		86,090		1,240		1,269		1,733		2,445		1.65			1.47
Macomb Community Bank		84,842		91,173		1,234		1,327		2,169		1,768		1.45			1.46
Muskegon Commerce Bank		90,469		88,692		905		904		1,889		1,524		1.00			1.02
Oakland Commerce Bank		94,159		107,037		1,394		1,850		1,062		2,402		1.48			1.73
Paragon Bank & Trust		95,964		96,428		1,320		1,350		2,554		783		1.38			1.40
Portage Commerce Bank		175,172		170,479		1,946		1,977		2,518		2,820		1.11			1.16
Great Lakes Region Total		1,535,089		1,517,700		21,038		20,960		22,643		25,872
Southeast Region:
First Carolina State Bank		62,843		51,867		632		525		102		11		1.01			1.01
Peoples State Bank(2)		17,098		n/a		107		n/a		19		n/a		0.63			n/a
Southeast Region Total		79,941		51,867		739		525		121		11
Eastern Regions Total		1,615,030		1,569,567		21,777		21,485		22,764		25,883
Western Regions:
Southwest Region:
Arrowhead Community Bank		71,087		62,737		700		620		276		29		0.98			0.99
Bank of Las Vegas		47,905		41,134		450		425		—		—		0.94			1.03
Bank of Tucson		125,544		115,694		1,255		1,170		372		455		1.00			1.01
Black Mountain Community Bank		98,462		84,163		1,244		1,014		438		368		1.26			1.20
Camelback Community Bank		72,128		75,146		1,035		1,186		—		—		1.43			1.58
Desert Community Bank		70,348		58,751		830		722		273		107		1.18			1.23
East Valley Community Bank		41,381		42,614		525		520		—		—		1.27			1.22
Fort Collins Commerce Bank(3)		14,241		n/a		147		n/a		—		n/a		1.03			n/a
Mesa Bank		116,130		85,561		1,125		800		—		—		0.97			0.94
Red Rock Community Bank		84,371		72,938		1,450		1,714		227		762		1.72			2.35
Southern Arizona Community Bank		73,561		72,226		700		736		20		—		0.95			1.02
Sunrise Bank of Albuquerque		55,423		59,766		1,012		895		725		459		1.83			1.50
Sunrise Bank of Arizona		104,314		118,617		1,250		1,400		64		111		1.20			1.18
Valley First Community Bank		53,338		49,518		426		469		—		—		0.80			0.95
Yuma Community Bank		49,585		41,460		460		465		—		—		0.93			1.12
Southwest Region Total		1,077,818		980,325		12,609		12,136		2,395		2,291
California Region:
Bank of Escondido		37,280		33,166		451		350		24		—		1.21			1.06
Bank of San Francisco(6)		3,010		n/a		31		n/a		—		n/a		1.03			n/a
Napa Community Bank		64,995		53,033		740		720		52		—		1.14			1.36
Point Loma Community Bank		26,545		8,590		265		88		—		—		1.00			1.02
Sunrise Bank of San Diego		56,722		46,945		514		415		—		297		0.91			0.88
California Region Total		188,552		141,734		2,001		1,573		76		297
Northwest Region — Bank of Bellevue(4)		5,565		n/a		62		n/a		—		n/a		1.11			n/a
Western Regions Total		1,271,935		1,122,059		14,672		13,709		2,471		2,588
Other, net		1,601		1,278		2,835		2,378		—		—		—			—
Consolidated	$	2,888,566	$	2,692,904	$	39,284	$	37,572	$	25,235	$	28,471		1.36	%		1.40	%

n/a — Not applicable.
(1)	Commenced operations in January 2005 and is 51%-owned by Capitol Development Bancorp Limited I, a controlled subsidiary of Capitol.
(2)	Acquired in April 2005 and is 62%-owned by Capitol.
(3)	Commenced operations in June 2005 and is 51%-owned by Capitol Bancorp Colorado Limited, a wholly-owned subsidiary of Capitol.
(4)	Commenced operations in June 2005 and is 51%-owned by Capitol Development Bancorp Limited II, a controlled subsidiary of Capitol.
(5)	Commenced operations in July 2005 and is 51%-owned by Capitol Development Bancorp Limited II, a controlled subsidiary of Capitol.
(6)	Commenced operations in August 2005 and is 51%-owned by Capitol.

 Page 18 of 29

Results of Operations

     Net income for the three months ended September 30, 2005 was a new record quarterly level, $9.6 million, an increase of $2.2 million (29%) over the same period in 2004; diluted earnings per share were $0.61 for the 2005 period compared to $0.50 in 2004. Net income for the nine months ended September 30, 2005 was $25.9 million, an increase of $7.1 million or 38% over the same period in 2004. Diluted earnings per share for the nine-month 2005 period were $1.67 compared to $1.27 in the corresponding period of 2004. Notably, the consolidated earnings contribution of Capitol’s western region banks surpassed the net income of Capitol’s eastern region banks in the 2005 periods.

     Net interest income for the nine-month 2005 period totaled $115.2 million, a 20% increase compared to $96.1 million in 2004. Net interest income for the third quarter of 2005 totaled $40.8 million, also a 20% increase, compared to $33.9 million for the comparable period in 2004. This increase is attributable to the banks’ growth in size and a continued strong net interest margin during a rising interest rate environment, which has resulted in yields on rate-sensitive assets (primarily variable-rate commercial loans) increasing faster than rates on interest-bearing liabilities.

     Noninterest income for the nine months ended September 30, 2005 was $15.1 million, an increase of $700,000, or 5%, over the same period in 2004. Noninterest income for the quarter ended September 30, 2005 was $4.9 million, an increase of $397,000, or 9%, over the same period in 2004. Fees from origination of nonportfolio residential mortgage loans totaled $1.8 million for the third quarter of 2005, and were $4.6 million for the nine-month period, as compared to $1.3 million and $4.2 million for the comparable periods in 2004, respectively, due to a larger volume of loan fees derived from residential mortgage activity despite higher interest rates and dynamic growth, particularly in Capitol’s western regions. Service charges on deposit accounts decreased slightly compared to 2004. Other noninterest income increased in the nine-month 2005 period primarily due to gains on sale of government-guaranteed commercial loans and fees earned from syndication of commercial loans to unaffiliated financial institutions.

     The provision for loan losses for the nine-month period in 2005 was $7.2 million, as compared to $9.6 million for the same period in 2004. The provision for loan losses for the three months ended September 30, 2005 was $2.1 million as compared to $3.6 million during the corresponding 2004 period. Provisions for loan losses in the 2005 periods were lower than in the prior year due primarily to significant improvements in asset quality. The provisions for loan losses are based upon management’s analysis of the adequacy of the allowance for loan losses, as previously discussed.

     Noninterest expense totaled $85.5 million for the nine-month period and $30.3 million for the third quarter in 2005, as compared to $71.7 million and $23.8 million, respectively, for the comparable periods in 2004. The increase in noninterest expense is associated with growth in the size of the banks and increases in general operating costs. Increases in both occupancy and salaries and employee benefits relate primarily to the growth in the size of banks within the consolidated group and the addition of six banks (compared to the addition of two banks in the nine-month 2004 period) and added regional bank development executives as part of Capitol’s 2005 expansion campaign.

Page 19 of 29

                     Operating results (dollars in thousands) were as follows:

	Nine months ended September 30
												Return on						Return on
	Total Revenues					Net Income						Average Equity(1)						Average Assets(1)
	2005			2004		2005			2004			2005			2004			2005			2004
Eastern Regions:
Great Lakes Region:
Ann Arbor Commerce Bank	$	17,894		$	16,157	$	3,423		$	3,161			16.91	%		16.32	%		1.39	%		1.31	%
Bank of Auburn Hills(6)		196			n/a		(278	)		n/a			n/a			n/a			n/a			n/a
Bank of Michigan(2)		367			n/a		(745	)		n/a			n/a			n/a			n/a			n/a
Brighton Commerce Bank		5,423			4,576		836			794			12.17			12.93			1.03			1.10
Capitol National Bank		11,958			10,212		2,853			2,605			20.44			20.34			1.59			1.55
Detroit Commerce Bank		4,666			2,760		437			66			8.68			1.78			.75			.16
Elkhart Community Bank		3,858			2,859		506			525			8.65			9.90			.93			1.21
Goshen Community Bank		2,907			2,372		24			373			.49			7.83			.06			1.03
Grand Haven Bank		6,357			5,235		803			(112	)		10.49			n/a			.88			n/a
Kent Commerce Bank		4,643			3,957		477			408			7.68			6.65			.73			.68
Macomb Community Bank		4,878			4,242		567			596			8.58			9.06			.80			.87
Muskegon Commerce Bank		5,361			4,602		991			1,082			13.72			15.68			1.39			1.66
Oakland Commerce Bank		6,588			5,681		1,504			520			19.18			6.96			1.58			.54
Paragon Bank & Trust		6,347			5,208		599			790			7.00			9.47			.72			.99
Portage Commerce Bank		10,308			8,556		2,263			2,045			18.95			20.18			1.61			1.61
Great Lakes Region Total		91,751			76,417		14,260			12,853
Southeast Region:
First Carolina State Bank		3,294			1,591		454			326			5.65			4.23			.83			.65
Peoples State Bank(3)		902			n/a		71			n/a			4.06			n/a			.54			n/a
Southeast Region Total		4,196			1,591		525			326
Eastern Regions Total		95,947			78,008		14,785			13,179
Western Regions:
Southwest Region:
Arrowhead Community Bank		5,158			3,748		857			505			16.28			11.63			1.44			1.04
Bank of Las Vegas		2,953			2,068		443			77			8.98			1.72			1.06			.18
Bank of Tucson		9,230			7,425		2,790			2,159			28.03			24.39			2.13			1.84
Black Mountain Community Bank		6,361			4,471		1,589			980			20.70			15.27			1.80			1.41
Camelback Community Bank		4,405			4,083		892			286			14.06			4.39			1.46			.47
Desert Community Bank		4,179			3,044		763			427			13.17			7.49			1.38			.97
East Valley Community Bank		2,786			2,383		209			150			5.76			4.83			.58			.46
Fort Collins Commerce Bank(4)		361			n/a		(344	)		n/a			n/a			n/a			n/a			n/a
Mesa Bank		7,536			4,963		1,843			1,098			28.77			20.73			2.27			1.79
Red Rock Community Bank		5,202			4,462		1,200			358			13.02			3.90			1.53			.44
Southern Arizona Community Bank		4,467			4,106		938			976			14.24			15.81			1.42			1.56
Sunrise Bank of Albuquerque		3,952			3,937		732			674			14.25			14.84			1.42			1.27
Sunrise Bank of Arizona		7,718			8,756		1,515			1,847			16.57			22.22			1.63			1.88
Valley First Community Bank		3,390			2,358		517			188			10.53			4.21			1.02			.50
Yuma Community Bank		3,372			2,906		743			643			15.01			15.00			1.68			1.69
Southwest Region Total		71,070			58,710		14,687			10,368
California Region:
Bank of Escondido		2,708			1,350		311			(244	)		4.44			n/a			.70			n/a
Bank of San Francisco(7)		95			n/a		(451	)		n/a			n/a			n/a			n/a			n/a
Napa Community Bank		4,135			2,884		892			327			12.01			5.20			1.61			.69
Point Loma Community Bank		1,401			31		(378	)		(429	)		n/a			n/a			n/a			n/a
Sunrise Bank of San Diego		4,164			4,124		821			826			10.23			11.66			1.73			1.53
California Region Total		12,503			8,389		1,195			480
Northwest Region — Bank of Bellevue(5)		142			n/a		(362	)		n/a			n/a			n/a			n/a			n/a
Western Regions Total		83,715			67,099		15,520			10,848
Other, net		(1,460	)		88		(4,399	)		(5,261	)		n/a			n/a			n/a			n/a
Consolidated	$	178,202		$	145,195	$	25,906		$	18,766			13.19	%		10.76	%		1.06	%		.86	%

n/a — Not applicable.
(1)	Annualized for period presented.
(2)	Commenced operations in January 2005 and is 51%-owned by Capitol Development Bancorp Limited I, a controlled subsidiary of Capitol.
(3)	Acquired in April 2005 and is 62%-owned by Capitol.
(4)	Commenced operations in June 2005 and is 51%-owned by Capitol Bancorp Colorado Limited, a wholly-owned subsidiary of Capitol.
(5)	Commenced operations in June 2005 and is 51%-owned by Capitol Development Bancorp Limited II, a controlled subsidiary of Capitol.
(6)	Commenced operations in July 2005 and is 51%-owned by Capitol Development Bancorp Limited II, a controlled subsidiary of Capitol.
(7)	Commenced operations in August 2005 and is 51%-owned by Capitol.

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Liquidity and Capital Resources

     The principal funding source for asset growth and loan origination activities is deposits. Total deposits increased $267 million (exclusive of the April 2005 acquisition of Peoples State Bank) for the nine months ended September 30, 2005, more than the $175 million increase in the corresponding period of 2004 (excluding the April 2004 acquisition of First Carolina State Bank). Growth occurred in most interest-bearing deposit categories, with about half coming from time accounts. The banks generally do not significantly rely on brokered deposits as a key funding source; brokered deposits approximated $202 million as of September 30, 2005, or about 7% of total deposits, an increase of $21 million during the interim 2005 period. Brokered deposits, as a funding source, have increased in recent periods due to competitive environments and to aid in matching repricing of funding sources and assets.

     Noninterest-bearing deposits approximated 22% of total deposits at September 30, 2005 and 20% at December 31, 2004. Levels of noninterest-bearing deposits can, however, fluctuate based on customers’ transaction activity.

     Cash and cash equivalents amounted to $380 million or 11% of total assets at September 30, 2005, compared with $231 million or 7% of total assets at December 31, 2004. As liquidity levels vary continuously based on customer activities, amounts of cash and cash equivalents can vary widely at any given point in time. Management believes the banks’ liquidity position at September 30, 2005 is adequate to fund loan demand and meet depositor needs.

     In addition to cash and cash equivalents, a source of long-term liquidity is the banks’ portfolio of marketable investment securities. Liquidity needs have not historically necessitated the sale of investments in order to meet funding requirements. The banks have not engaged in active trading of their investments. At September 30, 2005, the banks had approximately $29 million of investment securities classified as available for sale which can be utilized to meet various liquidity needs as they arise.

     Several of the banks have secured lines of credit with regional Federal Home Loan Banks. Borrowings thereunder approximated $173 million and additional borrowing capacity approximated $160 million at September 30, 2005. These facilities are used from time to time as a lower-cost funding source versus various rates and maturities of time deposits. Total notes payable and short-term borrowings approximated $174 million at September 30, 2005, a slight increase over amounts outstanding at the beginning of the year. At September 30, 2005, Capitol had unused lines of credit from an unrelated financial institution aggregating $25 million.

     Stockholders’ equity, as a percentage of total assets, approximated 8.13% at September 30, 2005 and 8.16% at December 31, 2004.

     Bank of Michigan, located in Farmington Hills, Michigan, opened in January 2005. During June 2005, the following banks opened: Bank of Bellevue, located in Bellevue, Washington, and Fort Collins Commerce Bank, located in Fort Collins, Colorado. In early July 2005, Bank of Auburn Hills opened in Auburn Hills, Michigan. In early August 2005, Bank of San Francisco opened in San Francisco, California. These banks are majority-owned by Capitol or bank-development subsidiaries controlled by Capitol.

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     In April 2005, Capitol acquired a majority interest in Peoples State Bank (“Peoples”) located in Jeffersonville, Georgia, in a purchase transaction with total consideration approximating $2.2 million. Peoples’ total assets approximated $22.9 million at the acquisition date, including $1.2 million of goodwill relating to the purchase of the controlling interest in the bank by Capitol. Capitol’s acquisition of Peoples was accounted for under the purchase method of accounting and its results of operations are included in Capitol’s consolidated financial statements for periods after the effective date of the acquisition. The pro forma effect of this acquisition was not significant.

     In 2005, Capitol Development Bancorp Limited III was capitalized as a controlled subsidiary of Capitol, with approximately $16 million (including approximately $15 million provided by minority interests) to fund future bank development activity.

     Bank development efforts were in process at September 30, 2005 in several states pending approvals from regulatory agencies, including pre-development exploratory discussions, lease and employment negotiations and preparation of preliminary regulatory applications for formation and/or acquisition of community banks. At September 30, 2005, Capitol had applications pending for additionalde novocommunity banks in Arizona, California, Georgia, Illinois, Missouri and North Carolina.

     A share exchange offer transaction regarding Napa Community Bank was completed effective August 31, 2005. Shares acquired from the Bank’s shareholders accepting Capitol’s exchange offer were exchanged for Capitol’s common stock according to an exchange ratio. In total, Capitol issued approximately 202,000 shares of previously unissued common stock resulting from this transaction (for consideration approximating $6.4 million), increasing Capitol’s ownership of Napa Community Bank to approximately 87%. This acquisition of minority interests was recorded using the purchase-method of accounting. The pro forma effect of this transaction was not significant.

     Capitol’s operating strategy continues to be focused on the ongoing growth and maturity of its existing banks, coupled with new bank expansion in selected markets as opportunities arise. Accordingly, Capitol may invest in, acquire or otherwise develop additional banks in future periods, subject to economic conditions and other factors, although the timing of such additional banking units, if any, is uncertain. Such future new banks and/or additions of other operating units could be either wholly-owned, majority-owned or otherwise controlled by Capitol. Most recently, Capitol has recruited several regional bank development executives to pursuede novoand other bank development opportunities in certain regions of the United States where it seeks to expand in future periods.

     Capitol and its banks are subject to complex regulatory capital requirements, which require maintaining certain minimum capital ratios. These ratio measurements, in addition to certain other requirements, are used by regulatory agencies to determine the level of regulatory intervention and enforcement applied to financial institutions. Management believes Capitol and each of its banks are in compliance with regulatory requirements and are expected to maintain such compliance.

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Trends Affecting Operations

     One of the most significant trends which can impact the financial condition and results of operations of financial institutions is the impact of changes in market rates of interest.

     Changes in interest rates, either up or down, have an impact on net interest income (plus or minus), depending on the direction and timing of such changes. At any point in time, there is a difference between interest rate-sensitive assets and interest rate-sensitive liabilities. This means that when interest rates change, the timing and magnitude of the effect of such interest rate changes can alter the relationship between asset yields and the cost of funds.

     The Board of Governors of the Federal Reserve, which influences interest rates, has increased interbank borrowing rates several times during the interim 2005 period and expressed several concerns about a variety of economic conditions. Home mortgage refinancing volume has decreased from record 2003 levels, which has adversely impacted fee income from the origination of residential mortgages. Many of Capitol’s loans have variable-rates and, accordingly, such rate increases should result in higher interest income to Capitol in the near term; however, depositors will similarly expect higher rates of interest on their accounts, potentially offsetting much of the benefit of rising interest rates. The future outlook on interest rates and their impact on Capitol’s interest income, interest expense and net interest income is uncertain.

     Start-up banks generally incur operating losses during their early periods of operations. Recently formed start-up banks may not contribute consolidated earnings performance and start-up banks formed in 2005 and beyond may similarly negatively impact short-term profitability. Capitol seeks to reduce the adverse impact of early-period losses of start-up banks through the use of partial ownership of such banks and partially-owned development subsidiaries which own controlling interests in certain of thosede novobanks.

     General economic conditions also have a significant impact on both the results of operations and the financial condition of financial institutions.

     Media reports raising questions about the health of the domestic economy have continued in 2005. During the interim 2005 period, nonperforming loans have decreased, however, it is difficult to predict future movements in levels of nonperforming loans and related loan losses may increase as economic conditions, locally and nationally, evolve.

Impact of New Accounting Standards

     There are several new accounting standards either becoming effective or being issued in 2005. They are listed and discussed in Notes B and H of the accompanying condensed consolidated financial statements.

     There is one particularly important new accounting standard, effective for Capitol beginning January 1, 2006, which will change accounting for stock options. In December 2004, the Financial Accounting Standards Board (“FASB”) issued a revision of Statement No. 123. Statement No. 123(R),Share-Based Payment, is broader in scope than the original statement,

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which was more narrowly focused on stock-based compensation, and makes significant changes to accounting for “payments” involving employee compensation and “shares” or securities, in the form of stock options, restricted stock or other arrangements settled in the reporting entity’s securities. Most significant in the standard is the requirement that all stock options be measured at estimated fair value at the grant date and recorded as compensation expense over the requisite service period associated with the option, usually the vesting period. The revised standard was to become effective for interim periods beginning after June 30, 2005 and be applied prospectively to stock options granted after the effective date and any unvested stock options at that date; however, the SEC superseded the FASB’s implementation timetable in April 2005, changing the effective date to the beginning of 2006 for calendar-year public companies.

     Although Capitol’s management has not completed its analysis of the revised standard, the effect of the revised standard’s implementation will be recognition of compensation expense associated with stock options. Previously, Capitol has used the intrinsic-value method which did not result in expense recognition but, instead, required pro forma presentation of what compensation expense would have been recorded if the fair-value measurement and expense recognition provisions had been applied. Effective December 31, 2004, Capitol accelerated the vesting of all of its outstanding stock options in anticipation of implementation of Statement No. 123(R). Such acceleration of vesting, to make all such stock options vested as of December 31, 2004, was done for the purpose of avoiding future expense associated with any unvested stock options granted prior to the effective date of Statement No. 123(R). All stock options granted during the interim periods of 2005 vested at the grant date. As mentioned above, the current accounting standard in effect prior to the effective date of Statement No. 123(R) requires disclosure of what pro forma compensation expense would have been if stock options granted had been recorded at fair value using measurement techniques which are similar to those prescribed in Statement No. 123(R); such disclosures appear in the notes to the accompanying condensed consolidated financial statements. That presentation shouldnot be viewed as an estimate of future expense levels inasmuch as it is based on stock options granted in the periods presented which may differ significantly from future granting activity, assumptions used and the structure of share-based payment awards.

Critical Accounting Policies

     Capitol’s critical accounting policies are described on pages F-9, F-10 and F-11 of the financial section of its 2004 Annual Report. In the circumstances of Capitol, management believes its “critical accounting policies” are those which encompass the use of estimates in determining the allowance for loan losses (because of inherent subjectivity), accounting for stock options, goodwill and other intangibles (due to inherent subjectivity in evaluating potential impairment) and classification of trust-preferred securities.

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PART I, ITEM 3

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK

Information about Capitol’s quantitative and qualitative disclosures about market risk were included in Capitol’s annual report on Form 10-K for the year ended December 31, 2004. Capitol does not believe that there has been a material change in the nature or categories of market risk exposure, except as noted in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section herein (Part I, Item 2), under the caption, “Trends Affecting Operations”.

PART I, ITEM 4

CONTROLS AND PROCEDURES

Capitol maintains disclosure controls and procedures designed to provide reasonable assurance that the information Capitol must disclose in its filings with the Securities and Exchange Commission is recorded, processed, summarized and reported on a timely basis. Capitol’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated Capitol’s disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the period covered by this report (the “Evaluation Date”). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, Capitol’s disclosure controls and procedures, in all material respects, are effective in bringing to their attention on a timely basis material information relating to Capitol required to be included in Capitol’s periodic filings under the Exchange Act.

No change in Capitol’s internal control over financial reporting occurred during Capitol’s most recent fiscal quarter that has materially affected or is reasonably likely to materially affect Capitol’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

Capitol and its subsidiaries are parties to certain ordinary, routine litigation incidental to their business. In the opinion of management, liabilities arising from such litigation would not have a material effect on Capitol’s consolidated financial position or results of operations.

Item 2. Unregistered Sales of Securities and Use of Proceeds.

(a) None.

(b) Not applicable.

(c) None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Submission of Matters to a Vote of Security Holders.

None.

Item 5. Other Information.

None.

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits:

Exhibit No.		Description of Exhibit
	31.1	Certification of Chief Executive Officer, Joseph D. Reid, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	Certification of Chief Financial Officer, Lee W. Hendrickson, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of Chief Executive Officer, Joseph D. Reid, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	Certification of Chief Financial Officer, Lee W. Hendrickson, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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PART II. OTHER INFORMATION — Continued

(b) Reports on Form 8-K:

On July 21, 2005, a report on Form 8-K was filed, reporting second quarter earnings.

On July 26, 2005, a report on Form 8-K was filed, reporting a third quarter 2005 dividend.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

CAPITOL BANCORP LTD.

(Registrant)

/s/ Joseph D. Reid

Joseph D. Reid

Chairman and CEO

(duly authorized to sign on behalf of the registrant)

/s/ Lee W. Hendrickson

Lee W. Hendrickson

Chief Financial Officer

Date: October 31, 2005

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INDEX TO EXHIBITS

Exhibit No.	Description of Exhibit
31.1	Certification of Chief Executive Officer, Joseph D. Reid, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer, Lee W. Hendrickson, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer, Joseph D. Reid, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Chief Financial Officer, Lee W. Hendrickson, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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