ConnectOne Bancorp - 10-Q quarterly report FY

The following unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X, and, accordingly, do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine-months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2006, or for any other interim period. The Center Bancorp Inc. 2005 Annual Report on Form 10-K should be read in conjunction with these statements.

The consolidated financial statements of Center Bancorp, Inc. (the “Corporation”) are prepared on the accrual basis and include the accounts of the Corporation and its wholly owned subsidiaries, including Union Center National Bank (the “Bank”). All significant inter-company accounts and transactions have been eliminated from the accompanying consolidated financial statements.

The Corporation is a bank holding company whose principal activity is the ownership and management of Union Center National Bank. The Bank provides a full range of banking services to individual and corporate customers through branch locations in Union and Morris Counties, New Jersey. Additionally, the Bank originates residential mortgage loans and services such loans for others. The Bank is subject to competition from other financial institutions and the regulations of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities.

The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the statement of condition and revenues and expenses for the reported periods. Actual results could differ significantly from those estimates.

In the opinion of Management, all adjustments necessary for a fair presentation of the Corporation’s financial condition and results of operations for the interim periods have been made. Such adjustments are of a normal recurring nature. Certain reclassifications have been made for 2005 to conform to the classifications presented in 2006. Results for the period ended September 30, 2006 are not necessarily indicative of results for any other interim period or for the entire fiscal year. Reference is made to the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2005 for information regarding accounting principles.

Effective January 1, 2006, the Corporation adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123R using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, stock-based compensation expense for the nine-months ended September 30, 2006 includes compensation expense for all stock-based compensation awards granted, but not yet vested, as of December 31, 2005 based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123 “Accounting for stock-based compensation”. The stock-based compensation expense for all stock-based compensation awards granted after that date is based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. The Corporation will recognize these expenses on a straight-line method over the requisite service period of the stock award, which is the vesting term. Prior to the adoption of SFAS 123R, the Corporation recognized stock-based compensation expense in accordance with APB 25. In March of 2005, the Securities and Exchange Commission (the “SEC”) issued a Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of SFAS 123R and the valuation of share-based payments for public companies. The Corporation has applied the provisions of SAB 107 in its adoption of SFAS 123R. See Note 3 of the Consolidated Financial Statements for a further discussion.

The Corporation completed the acquisition of Red Oak Bank as of the close of business on May 20, 2005. Pursuant to the terms of the Agreement and Plan of Merger, 50% of Red Oak Bank’s common stock was converted into Center Bancorp, Inc. common stock at an exchange rate of .9227 Center Bancorp, Inc. shares per each Red Oak Bank share and 50% was converted into $12.06 in cash for each Red Oak Bank share. The aggregate consideration paid in the merger consisted of $13.3 million in cash and 1,015,816 shares of the Corporation’s common stock. The Corporation additionally converted remaining stock options covering 56,266 shares of Red Oak Bank common stock outstanding at the time of the merger and were exchanged for options covering 54,514 shares of Center Bancorp, Inc. common stock.

As a result of the Red Oak Bank acquisition, the Corporation acquired assets having a fair value of $115.3 million, including $89.6 million of net loans, $5.4 million of investment securities and $2.4 million of cash and cash equivalents, and assumed $70.7 million of deposits, $17.1 million of borrowings, and $792,000 of other liabilities.

The acquisition was accounted for as a purchase and the excess cost over the fair value of net assets acquired (“goodwill”) in the transaction was $14.7 million. Under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142, goodwill is not being amortized in connection with this transaction and the goodwill will not be deductible for income tax purposes. The Corporation also recorded a core deposit intangible of $702,617 in connection with the acquisition, which is being amortized on a 10-year sum of the digits method. The amortization of premiums and discounts resulting from the fair value adjustments of assets and liabilities amounted to approximately $323,342 for the year ended December 31, 2005. The results of operations for 2005 include Red Oak Bank’s results of operations from May 20, 2005 forward.

At September 30, 2006, the Corporation maintained a number of stock-based compensation plans from which new grants could be issued. The Corporation’s stock option plans permit Center Bancorp, Inc.’s common stock to be issued to key employees and directors of the Corporation and the Bank. The options and/or awards made under the plans are intended to be Incentive Stock Options, Non-qualified Stock Options or Restricted Awards. Under the 1999 Employee Stock Incentive Plan, an aggregate of 217,291 shares remain available under the plan and are authorized for issuance. Under the 2003 non-employee director stock option plan, an aggregate of 455,170 shares remain available under the plan and are authorized for issuance. Such shares may be Treasury shares, newly issued or a combination thereof. These plans also authorize the use of restricted stock awards.

The total compensation expense related to these plans was $45,000 and $119,000 for the three and nine-months ended September 30, 2006, respectively. Prior to December 31, 2005, the Corporation accounted for those plans under the recognition and measurement provisions of APB 25. Accordingly, the Corporation generally recognized compensation expense only when it granted options with a discounted exercise price. As a result, during that period, no stock-based employee compensation expense or any resulting compensation expense was recognized ratably over the associated service period, which was generally the option vesting term.

Prior to December 31, 2005, the Corporation provided pro forma disclosure amounts in accordance with SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (“SFAS 148”), as if the fair value method defined by SFAS 123 had been applied to its stock-based compensation.

Effective January 1, 2006, the Corporation adopted the fair value recognition provisions of SFAS 123R, using the modified prospective transition method and therefore has not restated prior period results. Under this transition method, stock-based compensation expense for the first nine-months of fiscal 2006 included compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of, December 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123. Stock-based compensation expense for all share-based payment awards granted after December 31, 2005 is based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. The Corporation recognizes these compensation costs net of a forfeiture rate and recognizes the compensation costs for only those shares expected to vest on a straight-line

As a result of adopting SFAS 123R, the impact to the Consolidated Financial Statements for the nine-months ended September 30, 2006, for income before income taxes and net income was $119,000 and $71,000 lower, respectively. There was no impact on either basic or diluted earnings per share for the nine-months ended September 30, 2006.

Under the principal option plans, the Corporation may grant certain employees restricted stock awards. Restricted stock awards are non-vested stock awards. Restricted stock awards are independent of option grants and are generally subject to forfeiture if employment terminates prior to the release of the restrictions. Such awards generally vest within 30 days to five years from the date of grant. During that period, ownership of the shares cannot be transferred. Restricted stock has the same cash dividend and voting rights as other common stock and is considered to be currently issued and outstanding. The Corporation expenses the cost of the restricted stock awards, which is determined to be the fair market value of the shares at the date of grant, ratably over the period during which the restrictions lapse.

In light of new accounting guidance under SFAS 123R, beginning in the first quarter of fiscal 2006, the Corporation reviewed its assumptions used in estimating the fair value of employee options granted. As part of this review, management concluded that it would use historical volatility. There were no grants of restricted stock for the nine-months ended September 30, 2006. In 2005, 8,500 shares of restricted stock were awarded.

There were no grants of stock options issued during the three-months ended September 30, 2006.  For the nine-months ended September 30, 2006 the fair value of share-based payment awards was estimated using the Black-Scholes option-pricing model with the following assumptions and weighted average fair values:

The aggregate intrinsic value of options above represents the total pretax intrinsic value (the difference between the Corporation’s closing stock price on the last trading day of the first nine-months of fiscal 2006 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2006. This amount changes based on the fair market value of the Corporation’s stock.

As of September 30, 2006, $324,662 of total unrecognized compensation cost related to stock options is expected to be recognized over a weighted-average period of 2.7 years.

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that companies recognize in their financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. Management is currently evaluating the impact of adopting FIN 48 on the Corporation’s financial statements.

In March 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 156, “Accounting for Servicing of Financial Assets.” SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities. SFAS No. 156 amends Statement 140 to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. This statement permits, but does not require, the subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value. An entity that uses derivative instruments to mitigate the risks inherent in servicing assets and servicing liabilities is required to account for those derivative instruments at fair value. Under this Statement, an entity can elect subsequent fair value measurement to account for its separately recognized servicing assets and servicing liabilities. By electing that option, an entity may simplify its accounting because this Statement permits income statement recognition of the potential offsetting changes in fair value of those servicing assets and servicing liabilities and derivative instruments in the same accounting period. The Statement is effective in the first fiscal year beginning after September 15, 2006 with earlier adoption permitted. The Corporation does not expect the adoption of Statement No. 156 to have a material impact on its financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS No. 157). SFAS No. 157 establishes a common definition for fair value to be applied to US GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Corporation is currently assessing the impact of SFAS No. 157 on its consolidated financial position and results of operations.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (SFAS No. 158). SFAS No. 158 requires that employers recognize on a prospective basis the funded status of their defined benefit pension and other postretirement plans on their consolidated balance sheet and recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost. SFAS No. 158 also requires additional disclosures in the notes to financial statements. SFAS No. 158 is effective as of the end of fiscal years ending after December 15, 2006. The Corporation is currently assessing the impact of SFAS No. 158 on its consolidated financial position and results of operations.

In September 2006, the SEC staff issued Staff Accounting Bulletin (“SAB”) 108 “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB 108 requires that public companies utilize a “dual-approach” to assessing the quantitative effects of financial misstatements. This dual approach includes both an income statement focused assessment and a balance sheet focused assessment. The guidance in SAB 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. The Corporation is currently assessing the impact of adopting SAB 108 but does not expect that it will have a material effect on our consolidated financial position or results of operations.

Total comprehensive income includes all changes in equity during a period from transactions and other events and circumstances from non-owner sources. The Corporation’s other comprehensive income (loss) is comprised of unrealized holding gains and losses on securities available-for-sale and an additional minimum pension liability.

Disclosure of comprehensive income for the nine-months ended September 30, 2006 and 2005 is presented in the Consolidated Statements of Changes in Stockholders’ Equity.

Basic Earnings per Share (EPS) is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding. Diluted EPS includes any additional common shares as if all potentially dilutive common shares were issued (e.g. stock options). The Corporation’s weighted average common shares outstanding for diluted EPS include the effect of stock options outstanding using the Treasury Stock Method, which are not included in the calculation of basic EPS.

All per common share amounts have been adjusted retroactively for common stock splits and Common stock dividends impacting the periods presented.

The Corporation previously disclosed in its financial statements for the year ended December 31, 2005, that it expected to contribute $750,000 to its pension plans in 2006. As of September 30, 2006, the Corporation has contributed $563,000 to its pension plans. The Corporation presently does not anticipate increasing its total contributions for the year to fund its pension plan obligations in 2006.

During 2001 and 2003, the Corporation issued $10.3 million and $5.2 million, respectively, of subordinated debentures and formed statutory business trusts, which exist for the exclusive purpose of (i) issuing trust securities representing undivided beneficial interests in the assets of the trusts; (ii) investing the gross proceeds of the trust securities in junior subordinated deferrable interest debentures (subordinated debentures) of the Corporation; and (iii) engaging in only those activities necessary or incidental thereto. These subordinated debentures and the related income effects are not eliminated in the consolidated financial statements as the statutory business trusts are not consolidated in accordance with FASB interpretation No. 46 “Consolidation of Variable interest Entities.” Distributions on the subordinated debentures owned by the subsidiary trusts below are classified as interest expense in the Consolidated Statement of Income.

The characteristics of the business trusts and capital securities have not changed with the deconsolidation of the trusts. The capital securities provide an attractive source of funds since they constitute Tier 1 capital for regulatory purposes, but have the same tax advantages as debt for Federal income tax purposes.

On March 1, 2005, the Board of Governors of the Federal Reserve System adopted a final rule that allows the continued inclusion of outstanding and prospective issuances of trust preferred securities in the Tier I capital of bank holding companies, subject to stricter quantitative limits and qualitative standards. The new quantitative limits become effective after a five-year transition period ending March 31, 2009. Under the final rules, trust preferred securities and other restricted core capital elements are limited to 25% of all core capital elements. Amounts of restricted core capital elements in excess of these limits may be included in Tier II Capital. At September 30, 2006, the only restricted core capital element owned by the Corporation is trust preferred securities. Based on a preliminary review of the final rule, the Corporation believes that its trust preferred issues qualify as Tier I Capital. However, in the event that the trust-preferred issues would not qualify as Tier I Capital, the Corporation would remain well capitalized based on the Corporation’s financial condition as of September 30, 2006.

As of September 30, 2006, assuming the Corporation was not allowed to include the $15.5 million in subordinated debentures in Tier 1 capital, the Corporation would have had a Tier 1 capital ratio of 12.30% and a total risk based capital ratio of 13.03%.

To the extent that the trusts have funds available to make payments, as guarantor, the Corporation continues to unconditionally guarantee payment of required distributions on the capital securities; the redemption price when a capital security is redeemed; and the amounts due if a Trust is liquidated or terminated. During the first nine-months of 2006, the business trusts did not repurchase any capital securities or related debentures.

This report includes forward-looking statements within the meaning of Sections 27A of the Securities Act of 1933, as amended, and 21E of the Securities Exchange Act of 1934, as amended, with respect to the financial condition, results of operations, plans, objectives, future performance and business of Center Bancorp, including statements preceded by, followed by or that include the words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue,” “remain,” “pattern” or similar expressions or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may” or similar expressions. Such forward-looking statements involve inherent risks and uncertainties. There are a number of important factors that could cause actual results to differ materially from historical performance and from these forward-looking statements. Factors that might cause such a difference include, but are not limited to: (1) competitive pressures among depository institutions may increase significantly; (2) the interest rate environment may change; (3) prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions may reduce interest margins; (4) general economic conditions may be less favorable than expected; (5) political developments, wars, terrorism or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (6) legislative or regulatory changes or actions may adversely affect the businesses in which Center Bancorp is engaged; (7) changes and trends in the securities markets may affect the Corporation’s common stock; (8) a delayed or incomplete resolution of regulatory issues may negatively impact the services provided by Union Center National Bank, the banking subsidiary of Center Bancorp (the “Bank”); (9) the developments discussed above may have a material adverse effect on the Corporation’s business generation and retention, funding and liquidity; and (10) the outcome of regulatory and legal investigations and proceedings cannot always be predicted accurately. Further information on other factors that could affect the financial results of Center Bancorp are included in Center Bancorp’s filings with the Securities and Exchange Commission. These documents are available free of charge at the Commission’s website at http://www.sec.gov and/or from Center Bancorp. The Corporation assumes no obligation for updating any such forward-looking statement at any time.

The accounting and reporting policies followed by Center Bancorp, Inc. and its subsidiaries (the “Corporation”) conform, in all material respects, to U.S. generally accepted accounting principles. In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated statements of condition and results of operations for the periods indicated. Actual results could differ significantly from those estimates.

The Corporation’s accounting policies are fundamental to understanding Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations. The most significant accounting policies followed by the Corporation are presented in Note 1 of the Notes to Consolidated Financial Statements in the Corporation’s 2005 annual report incorporated by reference to its 2005 report on Form 10K. The Corporation has identified its policies on the allowance for loan losses and income tax liabilities to be critical because management has to make subjective and/or complex judgments about matters that are inherently uncertain and could be most subject to revision as new information becomes available.

The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the Consolidated Statements of Condition. Note 1 of the Notes to Consolidated Financial Statements in the Corporation’s 2005 Annual Report incorporated by reference to its 2005 report on Form 10-K and page 21 of this Quarterly Report on Form 10-Q under “Allowance for Loan Losses and Related Provisions”, describe the methodology used to determine the allowance for loan losses and discuss the factors driving changes in the amount of the allowance for loan losses.

The evaluation of the adequacy of the allowance for loan losses includes, among other factors, an analysis of historical loss rates by loan category applied to current loan totals. However, actual loan losses may be higher or lower than historical trends, which vary. Actual losses on specified problem loans, which also are provided for in the

The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in the Corporation’s consolidated financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could impact the Corporation’s consolidated financial condition or results of operations. Notes 1 and 10 of the Notes to Consolidated Financial Statements in the Corporation’s 2005 Annual Report on Form 10-K include additional discussion on the accounting for income taxes.

The Company accounts for goodwill and other identifiable intangible assets in accordance with SFAS No. 142, “Goodwill and intangible assets.” SFAS No. 142 includes requirements to test goodwill and indefinite lived intangible assets for impairment rather than amortize them. The Corporation tested the goodwill as of December 31, 2005, and determined that it is not impaired.

Net income for the three-months ended September 30, 2006 amounted to $1,302,000 compared to $2,036,000 earned for the comparable three-month period ended September 30, 2005. On a fully diluted per share basis, earnings decreased to $.10 per share as compared with $.15 per share for the three-months ended September 30, 2005. The annualized return on average assets decreased to 0.50 percent compared with 0.70 percent for the comparable three-month period in 2005. The annualized return on average stockholders’ equity was 5.48 percent for the three-month period ended September 30, 2006 as compared to 8.08 percent for the three-months ended September 30, 2005.

In March 2006, the Corporation restructured its balance sheet. As part of the restructuring, the Corporation sold $86.3 million available for sale securities, which were yielding less than 4% per annum. The sale resulted in a charge of $3.6 million ($2.4 million net of tax). As a result, the Corporation recorded net income for the nine-months ended September 30, 2006 in the amount of $1,607,000 compared to net income of $5,714,000 for the comparable nine-month period ended September 30, 2005. On a fully diluted per share basis, earnings decreased to $.12 per share as compared with $.49 per share for the nine-months ended September 30, 2005. The annualized return on average assets decreased to 0.20 percent compared with 0.70 percent for the comparable nine-month period in 2005. The annualized return on average stockholders’ equity was 2.22 percent for the nine-month period ended September 30, 2006 as compared to 9.37 percent for the nine-months ended September 30, 2005.

Net interest income is the difference between the interest earned on the portfolio of earning-assets (principally loans and investments) and the interest paid for deposits and short-term borrowings, which support these assets. Net interest income is presented below first on a fully tax-equivalent basis by adjusting tax-exempt income (primarily interest earned on various obligations of state and political subdivisions) by the amount of income tax which would have been paid had the assets been invested in taxable issues and then in accordance with the Corporation’s consolidated financial statements.

Net interest income on a fully tax-equivalent basis decreased $1,280,000 or 16.39 percent to $6.5 million for the three-months ended September 30, 2006, from $7.8 million for the comparable period in 2005. For the three-months ended September 30, 2006, the annualized net interest margin (i.e., net interest income as a percentage of interest-earning assets) decreased 19 basis points to 2.70 percent from 2.89 percent due primarily to higher rates paid on interest-bearing assets. For the three-months ended September 30, 2006, an increase in the annualized average yield on interest-earning assets of 63 basis points was offset by an increase in the annualized average cost of interest-bearing liabilities of 96 basis points, which reduced the Corporation’s annualized net interest spread by 33 basis points.

Net interest income on a fully tax-equivalent basis decreased $1,974,000 or 8.85 percent to $20.3 million for the nine-month period ended September 30, 2006, from $22.3 million for the comparable period in 2005. For the nine-months ended September 30, 2006, the net interest margin decreased 14 basis points to 2.79 percent from 2.93 percent due primarily to higher rates paid on interest-bearing liabilities. For the nine-months ended September 30, 2006, an increase in the average yield on interest-earning assets of 63 basis points was offset by an increase in the average cost of interest-bearing liabilities of 93 basis points, which reduced the Corporation’s net interest spread by 30 basis points.

For the three-month period ended September 30, 2006, interest income on a tax-equivalent basis decreased by $19,000 or 0.13 percent over the comparable three-month period in 2005. This decrease reflects a decrease in the volume of interest-earning assets. The Corporation’s loan portfolio increased on average $34.3 million to $532.4 million from $498.1 million in the same quarter of 2005, primarily driven by growth in commercial and commercial real estate. The loan portfolio represented approximately 55.2 percent of the Corporation’s interest-earning assets (on average) during the third quarter of 2006 and 46.0 percent in the same quarter in 2005. Average investment volume decreased during the period by $169.0 million compared to 2005, reflects the repositioning of the Corporation’s statement of condition during the first quarter of 2006.

The factors underlying the quarter-to-quarter changes in net interest income are reflected in the table appearing on page 15, which has been presented on a tax-equivalent basis (assuming a 34 percent tax rates). The tables on pages 18 and 19 (Average Statements of Condition with Interest and Average Rates) shows the Corporation’s consolidated average balance of assets, liabilities, and stockholders’ equity, the amount of income produced from interest-earning assets and the amount of expense resulting from interest-bearing liabilities and the interest income as a percentage of average interest-earning assets, for the three and nine month periods ended September 30, 2006 and 2005. The table presented on page 17 (Analysis of Variance in Net Interest Income Due to Volume and Rates) quantifies the impact on net interest income resulting from changes in average balances and average rates over the periods presented; any change in interest income or expense attributable to both changes in volume and changes in rate has been allocated in proportion to the relationship of the absolute dollar amount of change in each category.

The Federal Reserve Open Market Committee increased interest rates six times in the past year, a total of 150 basis points. The annualized yield on interest-earning assets, during the third quarter, grew to 5.89 percent from 5.26 percent in 2005 (a change of 63 basis points); this change was offset by higher rates paid for deposits and borrowings. The total annualized cost of interest-bearing liabilities increased to 3.76 percent, a change of 96 basis points, for the three-months ended September 30, 2006 from 2.80 percent for the three-months ended September 30, 2005. For the three-months ended September 30, 2006, the Corporation’s net interest spread on a tax-equivalent basis decreased to 2.13 percent from 2.46 percent for the three-months ended September 30, 2005.

For the nine-months ended September 30, 2006, the Corporation’s annualized yield on interest-earning assets increased to 5.71 percent from 5.08 percent in the comparable period in 2005 (a change of 63 basis points). This change was partially offset by higher rates paid for deposits and borrowings. The annualized total cost of interest-bearing liabilities increased to 3.47 percent, a change of 93 basis points, for the nine-months ended September 30, 2006 from 2.54 percent for the nine-months ended September 30, 2005. For the nine-months ended September 30, 2006, the Corporation’s net interest spread on a tax-equivalent basis decreased to 2.24 percent from 2.54 percent for the nine-months ended September 30, 2005.