Fulton Financial - 10-Q quarterly report FY

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes   þ   No   o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes   þ  No  o

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

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

The accompanying unaudited consolidated financial statements of Fulton Financial Corporation (the Corporation) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine-month periods ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005.

The Corporation adopted Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (Statement 123R) in the third quarter of 2005, using modified retrospective application. As a result, all prior period information has been restated. As a result of the retrospective adoption of this new standard, as of December 31, 2003 retained earnings decreased $13.2 million, additional paid in capital increased $14.6 million and deferred tax assets increased $1.4 million. These changes reflect a combination of compensation expense for prior stock option grants to employees and related tax benefits. See also, Note E “Stock-Based Compensation”.

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 of outstanding stock options.

A reconciliation of the weighted average shares outstanding used to calculate basic and diluted net income per share follows:

Total comprehensive income was $31.3 million and $104.4 million for the three and nine months ended September 30, 2005, respectively. Total comprehensive income was $59.6 million and $95.2 million for the three and nine months ended September 30, 2004, respectively.

The Corporation paid a 5-for-4 stock split in the form of a 25% stock dividend in June 2005. All share and per-share information has been restated to reflect the impact of this stock split.

The Corporation does not have any operating segments which require disclosure of additional information. While the Corporation owned fourteen separate banks as of September 30, 2005, each engaged in similar activities and provided similar products and services. The Corporation’s non-banking activities are immaterial and, therefore, separate information has not been disclosed.

Statement 123R requires that the fair value of equity awards to employees be recognized as compensation expense over the period during which an employee is required to provide service in exchange for such award. The Corporation adopted Statement 123R using “modified retrospective application”, electing to restate all prior periods. The Corporation’s equity awards consist of stock options granted under its Stock Option and Compensation Plans (Option Plans) and shares purchased by employees under its Employee Stock Purchase Plan (ESPP).

The following table summarizes the impact of modified retrospective application on the previously reported results for the periods shown:

The following table presents compensation expense and related tax benefits for equity awards recognized in the consolidated income statements:

Under the Option Plans, options are granted to key personnel for terms of up to 10 years at option prices equal to the fair market value of the Corporation’s stock on the date of grant. Options are typically granted annually on July 1^st and, prior to the July 1, 2005 grant, had been 100% vested immediately upon grant. For the July 1, 2005 grant, a three-year cliff vesting feature was added and, as a result, compensation expense associated with this grant will be recognized over the three year vesting period. This change in vesting resulted in a significant decrease in stock-based compensation expense in the third quarter of 2005 as compared to 2004. Certain events as defined in the Option Plans, including a change of control, would result in the acceleration of the vesting. As of September 30, 2005, the Option Plans had 14.9 million shares reserved for future grants through 2013.

The following table provides information about options outstanding for the nine months ended September 30, 2005:

The following table provides information about nonvested options for the nine months ended September 30, 2005:

As of September 30, 2005, total unrecognized compensation cost related to nonvested options was $2.4 million. This cost is expected to be recorded over a weighted average period of 2.8 years.

The following table presents information about options exercised:

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 Plans 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.

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 $2.52 for the July 1, 2005 grant and $2.78 for the July 1, 2004 grant. Approximately 1.1 million options were granted on July 1, 2005 and 1.3 million options were granted on July 1, 2004.

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.

The Corporation maintains a defined benefit pension plan (Pension Plan) for certain employees. Contributions to the Pension Plan are actuarially determined and funded annually. Pension Plan assets are invested in money markets, fixed income securities, including corporate bonds, U.S. Treasury securities and common trust funds, and equity securities, including common stocks and common stock mutual funds. The Pension Plan has been closed to new participants, but existing participants continue to accrue benefits according to the terms of the plan. The Corporation contributed approximately $10.6 million to the Pension Plan in the quarter ended September 30, 2005.

The Corporation currently provides medical and life insurance benefits under a post-retirement benefits plan (Post-Retirement Plan) to certain retired full-time employees who were employees of the Corporation prior to

January 1, 1998. Other certain full-time employees may become eligible for these discretionary benefits if they reach retirement age while working for the Corporation. Benefits are based on a graduated scale for years of service after attaining the age of 40.

The net periodic benefit cost for the Corporation’s Pension Plan and Post-Retirement Plan, as determined by consulting actuaries, consisted of the following components for the three and nine-month periods ended September 30:

On July 1, 2005, the Corporation completed its acquisition of SVB Financial Services, Inc. (SVB). SVB was a $530 million bank holding company whose primary subsidiary was Somerset Valley Bank (Somerset Valley), which operates 11 community-banking offices in Somerset, Hunterdon and Middlesex Counties in New Jersey.

Under the terms of the merger agreement, each of the approximately 4.1 million shares of SVB’s common stock was acquired by the Corporation based on a “cash election merger” structure. Each SVB shareholder elected to receive 100% of the merger consideration in stock, 100% in cash, or a combination of stock and cash.

As a result of the SVB shareholder elections, approximately 3.1 million of the SVB shares outstanding on the acquisition date were converted into shares of Corporation common stock, based on a fixed exchange ratio of 1.1899 shares of Corporation stock for each share of SVB stock. The remaining 983,000 shares of SVB stock were purchased for $21.00 per share. In addition, each of the options to acquire SVB’s stock was converted into options to purchase the Corporation’s stock or was settled in cash, based on the election of each option holder and the terms of the merger agreement. The total purchase price was $90.5 million, including $66.6 million in stock issued and stock options assumed, $22.4 million of SVB stock purchased and options settled for cash and $1.5 million for other direct acquisition costs. The purchase price for shares issued was determined based on the value of the Corporation’s stock on the date when the number of shares was fixed and determinable.

As a result of the acquisition, SVB was merged into the Corporation and Somerset Valley became a wholly owned subsidiary. The acquisition is being accounted for using purchase accounting, which requires the Corporation to allocate the total purchase price of the acquisition to the assets acquired and liabilities assumed, based on their respective fair values at the acquisition date, with any remaining purchase price being recorded as goodwill. Resulting goodwill balances are then subject to an impairment test on at least an annual basis. The results of Somerset Valley’s operations are included in the Corporation’s financial statements prospectively from the July 1, 2005 acquisition date.

The following is a summary of the preliminary purchase price allocation based on estimated fair values on the acquisition date. These preliminary amounts may be revised when final fair values are determined (in thousands):

On December 31, 2004, the Corporation completed its acquisition 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 stock options assumed and $610,000 in First Washington stock purchased for cash and other direct acquisition costs. The Corporation issued 1.69 shares of its stock for each of the 4.3 million shares of First Washington outstanding on the acquisition date. The purchase price was determined based on the value of the Corporation’s stock on the date when the final terms of the acquisition were agreed to and announced.

On April 1, 2004, the Corporation completed its acquisition of Resource Bankshares Corporation (Resource), an $890 million financial holding company, and its primary subsidiary, Resource Bank. Resource Bank is located in Virginia Beach, Virginia, and operates six community-banking offices in Newport News, Chesapeake, Herndon, Virginia Beach and Richmond, Virginia and fourteen loan production and residential mortgage offices in Virginia, North Carolina, Maryland and Florida.

The total purchase price was $195.7 million, including $185.9 million in stock issued and stock options assumed and $9.8 million in Resource stock purchased for cash and other direct acquisition costs. The Corporation issued 1.925 shares of its stock for each of the 5.9 million shares of Resource outstanding on the acquisition date. The purchase price was determined based on the value of the Corporation’s stock on the date when the final terms of the acquisition were agreed to and announced.

The following table summarizes unaudited pro-forma information assuming the acquisitions of Resource, First Washington and SVB had occurred on January 1, 2004. This pro-forma information includes certain adjustments, including amortization related to fair value adjustments recorded in purchase accounting (in thousands, except per-share information):

On July 26, 2005, the Corporation entered into a merger agreement to acquire Columbia Bancorp (Columbia), of Columbia, Maryland. Columbia is a $1.3 billion bank holding company whose primary subsidiary is The Columbia Bank, which operates 19 full-service community banking offices and five retirement community offices in Howard, Montgomery, Prince George’s and Baltimore Counties and Baltimore City.

Under the terms of the merger agreement, each of the approximately 6.9 million shares of Columbia’s common stock will be acquired based on a “cash election merger” structure. Each Columbia shareholder will have the ability to elect to receive 100% of the merger consideration in stock, 100% in cash, or a combination of stock and cash. Their elections will be subject to prorating to achieve a result where a minimum of 20% and a maximum of 50% of Columbia’s outstanding shares will receive cash consideration. Those shares that will be converted into Corporation common stock would be exchanged based on a fixed exchange ratio of 2.325 shares of Corporation stock for each share of Columbia stock. Shareholders electing cash will receive a fixed price of $42.48 per share of Columbia stock. In addition, each of the options to acquire Columbia’s stock will be converted to options to purchase the Corporation’s stock or will be settled in cash.

The acquisition is subject to approval by both the Columbia shareholders and applicable bank regulatory authorities and is expected to be completed during the first quarter of 2006. As a result of the acquisition, Columbia will be merged into the Corporation and The Columbia Bank will become a wholly-owned subsidiary.

The acquisition will be accounted for as a purchase. Purchase accounting requires the Corporation to allocate the total purchase price of the acquisition to the assets acquired and liabilities assumed, based on their respective fair values at the acquisition date, with any remaining acquisition cost being recorded as goodwill. Resulting goodwill balances are then subject to an impairment review on at least an annual basis. The results of Columbia’s operations will be included in the Corporation’s financial statements prospectively from the date of the acquisition.

The total purchase price is estimated to be approximately $295 million, which includes cash expected to be paid, the value of the Corporation’s stock expected to be issued, the value of Columbia’s options to be converted and certain acquisition-related costs. This purchase price is subject to change since the price used to value the shares issued in this transaction will be set on the date when the number of shares issued are fixed and determinable. The net assets of Columbia as of September 30, 2005 were $94.4 million and, therefore, the estimated purchase price exceeded the carrying value of the net assets by $200.6 million. The total purchase

price will be allocated to the net assets acquired as of the merger effective date, based on fair market values at that date. The Corporation expects to record a core deposit intangible asset and goodwill as a result of the acquisition accounting.

As of September 30, 2005, interest rate swaps with a notional amount of $270 million were used to hedge certain long-term fixed rate certificate of deposit liabilities held at one of the Corporation’s affiliate banks. The terms of the certificates of deposit and the interest rate swaps mirror each other and were committed to simultaneously. Under the terms of the swap agreements, the Corporation is the fixed rate receiver and the floating rate payer (generally tied to the three month London Interbank Offering Rate, or LIBOR, a common index used for setting rates between financial institutions). The combination of the interest rate swaps and the issuance of the certificates of deposit generates long-term floating rate funding for the Corporation. The interest rate swaps are classified as cash flow hedges and the fair values of the derivatives are recorded as other assets or other liabilities. Changes in the fair values during the period are recorded in other comprehensive income (loss) to the extent the hedge is effective. Ineffectiveness resulting from differences between the changes in fair value or cash flows of the certificate of deposits and the interest rate swaps must be recorded in current period earnings.

The Corporation’s analysis of the effectiveness of the hedges indicated they were 97.4% effective as of September 30, 2005. As a result, a $112,000 and $66,000 charge to income was recorded for the three and nine-month periods ended September 30, 2005, respectively. During the nine months ended September 30, 2005, the Corporation also recorded a $3.1 million other comprehensive loss (net of $1.7 million tax effect) to recognize the fair value changes of derivatives.

The Corporation entered into a forward-starting interest rate swap with a notional amount of $150 million in October 2005 in anticipation of an issuance of trust preferred securities in December 2005. This will be accounted for as a cash flow hedge as it hedges the variability of interest payments attributable to changes in interest rates on the forecasted issuance of fixed-rate debt.

The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Those financial instruments include commitments to extend credit and letters of credit, which involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Corporation’s Consolidated Balance Sheets. Exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the outstanding amount of those instruments.

The outstanding amounts of commitments to extend credit and letters of credit were as follows:

On March 28, 2005 the Corporation issued $100.0 million of ten-year subordinated notes, which mature April 1, 2015 and carry a fixed rate of 5.35%. Interest is paid semi-annually, commencing in October 2005.

In December 2003, 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 became effective for the Corporation on January 1, 2005 and was applicable to the July 2005 acquisition of SVB. Few of the loans acquired from SVB met the scope of SOP 03-3 and, as such, there was no material impact on the accounting for this acquisition.

Certain amounts in the 2004 consolidated financial statements and notes have been reclassified to conform to the 2005 presentation.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Management’s Discussion) concerns Fulton Financial Corporation (the Corporation), a financial holding company incorporated under the laws of the Commonwealth of Pennsylvania in 1982, and its wholly owned subsidiaries. This discussion and analysis should be read in conjunction with the consolidated financial statements and notes presented in this report.

The Corporation has made, and may continue to make, certain forward-looking statements with respect to its acquisition and growth strategies, management of net interest income and margin, the ability to realize gains on equity investments, allowance and provision for loan losses, expected levels of certain non-interest expenses and the liquidity position of the Corporation and Parent Company. The Corporation cautions that these forward-looking statements are subject to various assumptions, risks and uncertainties. Because of the possibility of changes in these assumptions, risks and uncertainties, actual results could differ materially from forward-looking statements.

In addition to the factors identified herein, the following could cause actual results to differ materially from such forward-looking statements: pricing pressures on loan and deposit products, actions of bank and non-bank competitors, changes in local and national economic conditions, changes in regulatory requirements, actions of the Federal Reserve Board (FRB), creditworthiness of current borrowers, customers’ acceptance of the Corporation’s products and services and acquisition pricing and the ability of the Corporation to continue making acquisitions .

The Corporation’s forward-looking statements are relevant only as of the date on which such statements are made. By making any forward-looking statements, the Corporation assumes no duty to update them to reflect new, changing or unanticipated events or circumstances.

As a financial institution with a focus on traditional banking activities, the Corporation generates the majority of its revenue through net interest income, or the difference between interest income earned on loans and investments and interest paid on deposits and borrowings. Growth in net interest income is dependent upon balance sheet growth and maintaining or increasing the net interest margin, which is net interest income as a percentage of average interest-earning assets. The Corporation also generates revenue through fees earned on the various services and products offered to its customers and through sales of assets, such as loans, investments, or properties. Offsetting these revenue sources are provisions for credit losses on loans, other operating expenses and income taxes.

The Corporation adopted Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (Statement 123R) in the quarter ended September 30, 2005. Statement 123R requires that the fair value of equity awards to employees be recognized as compensation expense over the period during which an employee is required to provide service in exchange for such award. The Corporation adopted Statement 123R using “modified retrospective application”, electing to restate all prior periods. As a result of adopting Statement 123R, net income and diluted net income per share for the third quarter of 2004 were reduced by $3.1 million and $0.03, respectively.

The Corporation’s net income for the third quarter of 2005 increased $6.1 million, or 17.0%, from $36.0 million in 2004 to $42.1 million in 2005. Diluted net income per share increased $0.04, or 17.4%, from $0.23 in 2004 to $0.27 in 2005. The Corporation realized annualized returns on average assets of 1.37% and average equity of

13.08% during the third quarter of 2005. The annualized return on average tangible equity, which is net income divided by average shareholders’ equity, excluding goodwill and intangible assets, was 20.62% for the quarter.

The increase in net income compared to the third quarter of 2004 resulted from a $14.3 million increase in net interest income after provision for loan losses and a $3.6 million increase in other income (excluding security gains), offset by a $2.4 million decrease in security gains, a $7.5 million increase in other expenses and a $1.8 million increase in income taxes.

The following summarizes some of the more significant factors that influenced the Corporation’s third quarter 2005 results.

Interest Rates – Changes in the interest rate environment generally impact both the Corporation’s net interest income and its non-interest income. The interest rate environment reflects both the level of short-term rates and the slope of the U. S. Treasury yield curve (Yield Curve), which plots the yields on treasury issues over various maturity periods. During the past year, the Yield Curve has flattened, with short-term rates increasing at a faster pace than longer-term rates.

Floating rate loans, short-term borrowings and savings and time deposit rates are generally influenced by short-term rates. The FRB raised the Federal funds rate eight times since September 2004, for a total increase of 200 basis points (from 1.75% to 3.75%). The Corporation’s prime lending rate had a corresponding increase, from 4.75% to 6.75%. The increase in short-term rates initially benefited the Corporation as floating rate loans quickly adjusted to higher rates, while increases in deposit rates – which are more discretionary – were less pronounced. As a result, the Corporation realized an increase in net interest margin in the third and fourth quarters of 2004 and the first quarter of 2005.

During the second and third quarters of 2005, competitive pressures resulted in increases in deposit rates. In addition, the Corporation issued $100 million of subordinated debt at 5.35% at the end of March 2005. As a result, the net interest margin decreased three basis points to 3.92% in the second quarter of 2005 and remained at 3.92% in the third quarter of 2005.

With respect to longer-term rates, the 10-year treasury yield, which is a common benchmark for evaluating residential mortgage rates, increased to 4.33% at September 30, 2005 as compared to 4.12% at September 30, 2004. Mortgage rates have been generally low over the past several years, generating strong refinance activity and significant gains for the Corporation as fixed-rate residential mortgages are generally sold in the secondary market. With only a minimal increase in long-term rates from the prior year, origination volume and the resulting gains on sales of these loans remained strong, continuing to contribute to the Corporation’s non-interest income.

The Corporation manages its risk associated with changes in interest rates through the techniques described in the “Market Risk” section of Management’s Discussion. As of September 30, 2005, the Corporation projects improvements in net interest income in a rising rate environment. Increases in long-term rates, however, may have a detrimental impact on mortgage loan origination volumes and related gains on sales of mortgage loans.

Earning Assets – The Corporation’s interest-earning assets increased from 2004 to 2005 as a result of acquisitions, as well as internal loan growth. This growth also contributed to the increase in net interest income.

From 2004 to 2005, the Corporation experienced a shift in its composition of interest-earning assets from investments (22.9% of total average interest-earning assets in 2005, compared to 25.1% in 2004) to loans (74.2% in 2005, compared to 73.6% in 2004). This change resulted from strong loan demand being funded with the proceeds from maturing investment securities, primarily mortgage-backed securities. The movement to higher-yielding loans has had a positive effect on the Corporation’s net interest income and net interest margin.

Asset Quality – Asset quality refers to the underlying credit characteristics of borrowers and the likelihood that defaults on contractual payments will result in charge-offs of account balances. Asset quality is generally a function of economic conditions, but can be managed through conservative underwriting and sound collection policies and procedures.

The Corporation continued to maintain excellent asset quality, attributable to its credit culture and underwriting policies. Annualized net charge-offs to average loans decreased to 0.02% in the third quarter of 2005, compared to 0.06% in 2004, contributing to a lower provision for loan losses. While overall asset quality has remained strong, deterioration in quality of one or several significant accounts could have a detrimental impact and result in losses that may not be foreseeable based on current information. In addition, rising interest rates could increase the total payments of borrowers and could have a negative impact on the ability of some to pay according to the terms of their loans.

Equity Markets – As noted in the “Market Risk” section of Management’s Discussion, equity valuations can have an impact on the Corporation’s financial performance. In particular, bank stocks account for a significant portion of the Corporation’s equity investment portfolio. Historically, gains on sales of these equities have been a recurring component of the Corporation’s earnings, although realized gains have decreased in recent quarters. Declines in bank stock portfolio values could have a detrimental impact on the Corporation’s ability to recognize gains in the future.

Acquisitions – In July 2005, the Corporation acquired SVB Financial Services, Inc. (SVB) of Somerville, New Jersey, a $530 million bank holding company whose primary subsidiary was Somerset Valley Bank. In December 2004, the Corporation acquired First Washington FinancialCorp (First Washington), a $490 million bank holding company located in Windsor, New Jersey whose primary subsidiary was First Washington State Bank. In April 2004, the Corporation acquired Resource Bankshares Corporation (Resource), an $890 million financial holding company located in Virginia Beach, Virginia whose primary subsidiary was Resource Bank. Results for 2005 in comparison to 2004 were impacted by these acquisitions, as documented in the appropriate sections of Management’s Discussion.

On July 26, 2005, the Corporation entered into a merger agreement to acquire Columbia Bancorp (Columbia), of Columbia, Maryland. Columbia is a $1.3 billion bank holding company whose primary subsidiary is The Columbia Bank, which operates 19 full-service community-banking offices and five retirement community offices in Howard, Montgomery, Prince George’s and Baltimore Counties and Baltimore City. For additional information on the terms of this pending acquisition, see Note G in the Notes to Consolidated Financial Statements.

Acquisitions have long been a supplement to the Corporation’s internal growth. These recent acquisitions provide the opportunity for additional growth, as they will allow the Corporation’s existing products and services to be sold in new markets. The Corporation’s acquisition strategy focuses on high growth areas with strong market demographics and targets organizations that have a comparable corporate culture, strong performance and good asset quality, among other factors. Under its “super-community” banking philosophy, acquired organizations generally retain their status as separate legal entities, unless consolidation with an existing affiliate bank is practical. Back office functions are generally consolidated to maximize efficiencies.

Merger and acquisition activity in the financial services industry has been very competitive in recent years, as evidenced by the prices paid for certain acquisitions. While the Corporation has been an active acquirer, management is committed to basing its pricing on rational economic models. Management will continue to focus on generating growth in the most cost-effective manner.

Merger and acquisition activity has also impacted the Corporation’s capital and liquidity. In order to complete acquisitions, the Corporation must have strategies in place to maintain appropriate levels of capital and to provide

necessary cash resources. In March 2005, the Corporation issued $100 million of subordinated debt, in part to support treasury stock repurchases related to acquisitions. This financing instrument also qualifies as a component of total regulatory capital. See additional information in the “liquidity” section of Management’s Discussion.

Results for the third quarter of 2005 compared to the results of the third quarter of 2004 were impacted by the December 2004 acquisition of First Washington and the July 2005 acquisition of SVB, whose results are included in 2005 amounts, but not in 2004. Results were also impacted by the adoption of Statement 123R (See Note E in the Notes to Consolidated Financial Statements).

Net interest income increased $14.0 million, or 15.1%, to $106.5 million in 2005 from $92.5 million in 2004. The increase was due to both average balance growth, with total earning assets increasing 14.2%, and a higher net interest margin. The average taxable equivalent yield on earning assets increased 67 basis points (a 12.6% increase) over 2004 while the cost of interest-bearing liabilities increased 78 basis points (a 45.3% increase). Despite the sharper increase in costs of interest-bearing liabilities, the net interest margin increased four basis points as non-interest bearing deposits also increased relative to total funding sources. The Corporation continues to manage its asset/liability position and interest rate risk through the methods discussed in the “Market Risk” section of Management’s Discussion.

The following table provides a comparative average balance sheet and net interest income analysis for the third quarter of 2005 compared to the same period in 2004. Interest income and yields are presented on a fully taxable-equivalent (FTE) basis, using a 35% Federal tax rate. The discussion following this table is based on these tax-equivalent amounts. All dollar amounts are in thousands.