.
.
.
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