Fulton Financial - 10-Q quarterly report FY

 

 

(Exact name of registrant as specified in its charter)

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

Common Stock, $2.50 Par Value – 173,396,000 shares outstanding as of October 31, 2007.

 

 

The accompanying unaudited consolidated financial statements of Fulton Financial Corporation (the Corporation) have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) 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 U.S. GAAP for complete financial statements. The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts of 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. 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, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.

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 and restricted stock. Excluded from the calculation were 4.4 million and 4.0 million anti-dilutive options for the three and nine months ended September 30, 2007, respectively, and 1.3 million anti-dilutive options for the three and nine months ended September 30, 2006.

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

Total comprehensive income was $47.6 million and $124.6 million for the three and nine months ended September 30, 2007, respectively. Total comprehensive income was $80.6 million and $146.6 million for the three and nine months ended September 30, 2006, respectively.

In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). The interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. Specifically, the interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.

The Corporation adopted the provisions of FIN 48 on January 1, 2007. As a result of adoption, the Corporation recognized a $220,000 decrease in existing reserves for unrecognized tax positions, which was accounted for as an increase to the January 1, 2007 balance of retained earnings.

As of the adoption date, the Corporation had unrecognized income tax benefits of $4.1 million, all of which, if recognized, would impact the effective tax rate. Also as of the adoption date, the Corporation had $1.4 million in accrued interest payable related to unrecognized tax benefits. The Corporation recognizes interest accrued related to unrecognized tax benefits as a component of income tax expense. Penalties, if incurred, would also be recognized in income tax expense. There have been no material changes to unrecognized tax benefits for the period ended September 30, 2007.

The Corporation, or one of its subsidiaries, files income tax returns in the U.S. Federal jurisdiction, and various states. In many cases, uncertain tax positions are related to tax years that remain subject to examination by the relevant taxable authorities. With few exceptions, the Corporation is no longer subject to U.S. Federal, state and local examinations by tax authorities for years before 2004.

As required by Statement of Financial Accounting Standards No. 123R, “Share-Based Payment”, the fair value of equity awards to employees is recognized as compensation expense over the period during which employees are required to provide service in exchange for such awards. The Corporation’s equity awards consist of stock options and restricted stock granted under its Stock Option and Compensation Plans (Option Plans) and shares purchased by employees under its Employee Stock Purchase Plan.

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

Under the Option Plans, options are granted to key employees for terms of up to ten 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 become fully vested after a three-year cliff-vesting period. Certain events, as specified in the Option Plans and agreements, would result in the acceleration of the vesting period. As of September 30, 2007, the Option Plans had 14.9 million shares reserved for the future grants through 2013. On July 1, 2007, the Corporation granted approximately 860,000 options under its Option Plans.

The Corporation maintains a defined benefit pension plan (Pension Plan) for certain employees. Contributions to the Pension Plan are actuarially determined and funded annually. Pension Plan assets are invested in money markets; fixed income securities, including corporate bonds, U.S. Treasury securities and common trust funds; and equity securities, including common stocks and common stock mutual funds. The Pension Plan has been closed to new participants, but existing participants will continue to accrue benefits according to the terms of the plan until December 31, 2007.

On April 30, 2007, the Corporation amended the Pension Plan to discontinue the accrual of benefits for all existing participants, effective January 1, 2008. As a result of this amendment, the Corporation recorded a $58,000 curtailment loss, as determined by consulting actuaries, during the quarter ended June 30, 2007. The curtailment loss resulted from a $14.0 million gain from adjusting the funded status of the Pension Plan and an offsetting $14.0 million write-off of unamortized pension costs and related deferred tax assets.

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. Certain other 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:

As of September 30, 2007, interest rate swaps with a notional amount of $268.0 million were used to hedge certain long-term fixed rate certificates of deposit. The terms of the certificates of deposit and the interest rate swaps are similar 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 interest rate swaps are classified as fair value hedges and both the interest rate swaps and the certificates of deposit are recorded at fair value, with changes in the fair values during the period recorded to other income or expense. For interest rate swaps accounted for as fair value hedges, ineffectiveness is the difference between the changes in the fair value of the interest rate swaps and the hedged items, in this case the certificates of deposit. The Corporation’s analysis of hedge effectiveness indicated the hedges were highly effective as of September 30, 2007. For the three and nine months ended

September 30, 2007, net losses of $10,000 and $251,000, respectively, were recorded in other expense, representing the net impact of the change in fair values of the interest rate swaps and the certificates of deposit, compared to net gains of $380,000 and $225,000, respectively, for the three and nine months ended September 30, 2006.

The Corporation entered into a forward-starting interest rate swap with a notional amount of $150.0 million in October 2005 in anticipation of the issuance of trust preferred securities in January 2006. This swap was accounted for as a cash flow hedge as it hedged the variability of interest payments attributable to changes in interest rates on the forecasted issuance of fixed-rate debt. The total amount recorded in accumulated other comprehensive income upon settlement of this derivative is being amortized to interest expense over the life of the related securities using the effective interest method. The amount of net losses in accumulated other comprehensive income that will be reclassified into earnings during the next twelve months is expected to be approximately $120,000.

In February 2007, the Corporation entered into a forward-starting interest swap with a notional amount of $100.0 million in anticipation of the issuance of subordinated debt in May 2007. This swap was accounted for as a cash flow hedge as it hedged the variability of interest payments attributable to changes in interest rates on the forecasted issuance of fixed-rate debt. The Corporation settled this derivative on its contractual maturity date in April 2007 with a total payment of $232,000 to the counterparty, including a $151,000 charge to other comprehensive income (net of an $81,000 tax effect). The total amount recorded in accumulated other comprehensive income is being amortized to interest expense over the life of the related securities using the effective interest method. The amount of net losses in accumulated other comprehensive income that will be reclassified into earnings during the next twelve months is expected to be approximately $15,000.

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 amounts 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:

During the three and nine months ended September 30, 2007, the Corporation recorded $16.0 million and $24.9 million, respectively, of charges related to the Corporation’s mortgage banking operations at Resource Bank (Resource Mortgage). These charges, included within operating risk loss in the Corporation’s Consolidated Statements of Income, were primarily due to actual and potential repurchases of residential mortgage loans and home equity loans which had been originated and sold to secondary market purchasers with standard representations and warranties regarding the origination of the loans, as well as standard agreements to repurchase the loans under specified circumstances.

Many of the loans repurchased or that may be repurchased are delinquent and would likely be settled through foreclosure and sale of the underlying collateral. The charges recorded in 2007 represent the estimated write-downs that are necessary to reduce the loan balances to their estimated net realizable values, based on valuations of the properties, as adjusted for market factors and other considerations.

During the third quarter, the Corporation repurchased approximately $35 million ($25.1 million net of valuation reserves) of residential mortgage loans and home equity loans from secondary market investors. Of these loans, $4.3 million were included in performing loans, $13.7 million were on non-accrual status and $7.1 million were classified as other real estate owned. As of September 30, 2007, outstanding repurchase requests totaled approximately $11 million and other loans identified that may be repurchased totaled approximately $24 million, with total valuation reserves of $12.6 million recognized as of September 30, 2007 for these loans.

Management believes that the reserves recorded as of September 30, 2007 are adequate for the known potential repurchases. However, continued declines in collateral values or the identification of additional loans to be repurchased could necessitate additional reserves in the future.

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.

In 2006, the Corporation’s Board of Directors approved a stock repurchase plan for 2.1 million shares through June 30, 2007. During the first quarter of 2007, the Corporation repurchased 1.0 million shares, representing the remaining shares available under this plan.

In April 2007, the Corporation’s Board of Directors approved a stock repurchase plan for 1.0 million shares through December 31, 2007. Repurchases under this plan will occur through open market acquisitions. During the three and nine months ended September 30, 2007, 135,000 shares were repurchased under this plan.

In May 2007, the Corporation issued $100.0 million of ten-year subordinated notes, which mature on May 1, 2017 and carry a fixed rate of 5.75%, an effective rate of approximately 5.95% as a result of issuance costs. Interest is paid semi-annually in May and November of each year.

In September 2006, the FASB ratified Emerging Issues Task Force (EITF) 06-4, “Accounting for Deferred Compensation and Post-retirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements “ (EITF 06-4). EITF 06-4 addresses accounting for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to post-retirement periods. EITF 06-4 would require that the post-retirement benefit aspects of an endorsement-type split-dollar life insurance arrangement be recognized as a liability by the employer if that obligation has not been settled through the related insurance arrangement. EITF 06-4 is effective for fiscal years beginning after December 15, 2007, or January 1, 2008 for the Corporation. The Corporation is currently evaluating the impact of EITF 06-4 on the consolidated financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurement” (Statement 157). Statement 157 defines fair value, establishes a framework for measuring fair value in U.S. GAAP, and expands disclosure requirements for fair value measurements. Statement

157 does not require any new fair value measurements and is effective for financial statements issued for fiscal years beginning after November 15, 2007, or January 1, 2008 for the Corporation. The Corporation is currently evaluating the impact of Statement 157 on the consolidated financial statements.

In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (Statement 159). Statement 159 permits entities to choose to measure many financial instruments and certain other items at fair value and amends Statement 115 to, among other things, require certain disclosures for amounts for which the fair value option is applied. Additionally, this standard provides that an entity may reclassify held-to-maturity and available-for-sale securities to the trading account when the fair value option is elected for such securities, without calling into question the intent to hold other securities to maturity in the future. This standard is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007, or January 1, 2008 for the Corporation. The Corporation has not completed its assessment of Statement 159 and the impact, if any, on the consolidated financial statements.

In March 2007, the FASB ratified EITF 06-10, “Accounting for Deferred Compensation and Post-retirement Benefit Aspects of Collateral Assignment Split-Dollar Life Insurance Arrangements” (EITF 06-10). EITF 06-10 addresses accounting for collateral assignment split-dollar life insurance arrangements that provide a benefit to an employee that extends to post-retirement periods.  EITF 06-10 provides guidance for determining the liability for the post-retirement benefit aspects of collateral assignment-type split-dollar life insurance arrangements, as well as the recognition and measurement of the associated asset on the basis of the terms of the collateral assignment agreement. EITF 06-10 is effective for fiscal years beginning after December 15, 2007, or January 1, 2008 for the Corporation. The adoption of EITF 06-10 is not expected to have a material impact on the consolidated financial statements.

In May 2007, the FASB issued Interpretation No. FIN 48-1, “Definition of Settlement in FASB Interpretation No. 48” (Staff Position No. FIN 48-1). Staff Position No. FIN 48-1 provides guidance on how to determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. Staff Position No. FIN 48-1 is effective retroactively to January 1, 2007. The implementation of this standard did not have an impact on the consolidated financial statements.

In June 2007, the FASB ratified EITF 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards” (EITF 06-11). EITF 06-11 requires that tax benefits associated with dividends on share-based payment awards be recorded as a component of additional paid-in capital. EITF 06-11 is effective, on a prospective basis, for fiscal years beginning after December 15, 2007, or January 1, 2008 for the Corporation. The adoption of EITF 06-11 is not expected to have a material impact on the consolidated financial statements.

Certain amounts in the 2006 consolidated financial statements and notes have been reclassified to conform to the 2007 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, the liquidity position of the Corporation and Parent Company and contingent liabilities. 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 risk factors could cause actual results to differ materially from such forward-looking statements:

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.

The Corporation currently derives the majority of its earnings from traditional banking activities, with net interest income, or the difference between interest income earned on loans and investments and interest paid on deposits and borrowings, accounting for approximately 77% of revenues for the three and nine months ended September 30, 2007. Growth in net interest income is dependent upon balance sheet growth 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 following table presents a summary of the Corporation’s earnings and selected performance ratios:

The Corporation’s net income for the third quarter of 2007 decreased $14.8 million, or 30.6%, from $48.3 million in 2006 to $33.6 million in 2007 due to an increase in other expenses of $15.6 million, or 16.8%, a decrease in net interest income of $3.5 million, or 2.8%, and a $4.1 million increase in the provision for loan losses, offset by an $8.5 million, or 39.6%, decrease in income tax expense. The increase in other expenses was due to $16.0 million in charges recorded during the third quarter of 2007 related to the Corporation’s mortgage banking operations at Resource Bank (Resource Mortgage). The decrease in net interest income was due to a 23 basis point decline in net interest margin, partially offset by balance sheet growth. The decrease in net interest margin was a result of lower interest income recoveries in 2007 ($3.3 million in 2006 and $396,000 in 2007) and the negative impact of funding loan growth and investment purchases with borrowings and time deposits as opposed to lower cost core demand and savings accounts. The loan loss provision increased due to higher net charge-offs during the third quarter of 2007 in comparison to the same period in 2006.

Net income for the nine months ended September 30, 2007 decreased $24.4 million, or 17.6%, from $138.9 million in 2006 to $114.5 million in 2007 due to increases in other expenses of $35.8 million, or 13.2%, and an increase of $5.8 million in the provision for loan losses, offset by a $12.7 million, or 20.8%, decrease in income tax expense and an increase in other income of $3.3 million, or 3.0%. The increase in other expenses was primarily due to $24.9 million in charges recorded during the first nine months of 2007 related to Resource Mortgage, and a $6.0 million increase in salaries and employee benefits.

The following summarizes some of the more significant factors that influenced the Corporation’s results for the three and nine months ended September 30, 2007.

Resource Mortgage – During the three and nine months ended September 30, 2007, the Corporation recorded $16.0 million and $24.9 million, respectively, of charges related to

Resource Mortgage. These charges were primarily due to actual and potential repurchases of residential mortgage loans and home equity loans which had been originated and sold to secondary market purchasers with standard representations and warranties regarding the origination of the loans, as well as standard agreements to repurchase loans under specified circumstances.

The following table presents a summary of approximate principal balances and related reserves recognized in the Consolidated Balance Sheet, by general category:

The following presents the activity in the reserve accounts for the three and nine months ended September 30, 2007:

The $16.0 million charge recorded during the three months ended September 30, 2007 included the following:

The $24.9 million charge recorded during the nine months ended September 30, 2007 included the charges detailed above, in addition to $8.9 million of charges related to outstanding repurchase requests.

During the third quarter, approximately $35 million ($25.1 million net of valuation reserves) of residential mortgage loans and home equity loans were repurchased from secondary market investors. Of these loans,

$4.3 million were included in performing loans, $13.7 million were on non-accrual status and $7.1 million were classified as other real estate owned.

In order to mitigate any future losses associated with the repurchase of previously originated and sold residential mortgage loans and home equity loans, the Corporation has exited from the national wholesale residential mortgage business at Resource Mortgage, which is where the majority of the repurchased loans were generated. In addition, Resource Mortgage now reports directly to Fulton Mortgage and, as previously disclosed in a separate filing, the Corporation intends to merge Resource Bank (including Resource Mortgage) into Fulton Bank in the first quarter of 2008.

In connection with preparing the consolidated financial statements included in this report, the Audit Committee of the Corporation’s Board of Directors engaged outside counsel to investigate whether there were additional potentially material occurrences of misrepresentations of borrower information that should be considered. The investigation involved sampling and analyzing data on loans originated by Resource Mortgage, examining underlying loan documentation on selected loans identified as a result of this analysis together with other records of the Corporation, and conducting interviews of relevant employees. Based on the results of the investigation, the Audit Committee and management concluded that no changes were required to the Corporation’s consolidated financial statements as of and for the three and nine months ended September 30, 2007.

Management believes that the reserves recorded as of September 30, 2007 for the known Resource Mortgage issues are adequate, based on the results of the aforementioned investigation, the assessment of collateral values and other market factors. However, continued declines in collateral values or the identification of additional loans to be repurchased could necessitate additional reserves in the future.

Interest Rates and Net Interest Margin – Changes in the interest rate environment can impact both the Corporation’s net interest income and its non-interest income. The term “interest rate environment” generally refers to both the level of interest rates and the shape of the U. S. Treasury yield curve, which is a plot of the yields on treasury issues over various maturity periods. Typically, the shape of the yield curve is upward sloping, with longer-term rates exceeding short-term rates. For the past twelve months, the yield curve has remained relatively flat, and at times, downward sloping, with minimal differences between long and short-term rates, resulting in a negative impact to the Corporation’s net interest income and net interest margin.

In September 2007, the Federal Reserve Board (FRB) lowered the Federal funds rate 50 basis points (from 5.25% to 4.75%). The Corporation’s prime lending rate had a corresponding decrease in September 2007, from 8.25% to 7.75%.

The decrease in short-term rates resulted in a decrease in the rates on floating rate loans which reprice consistently with market rates. Additionally, the decrease resulted in lower funding costs in the form of short-term borrowings and certain deposit accounts. However, due to competitive pressures, rates on savings and time deposits have not decreased as significantly as the Federal funds rate. Since this rate change occurred late in the third quarter, there was not a significant effect on net interest margin.

In comparison to the third quarter of 2006, the Corporation experienced a shift from lower cost demand and savings deposit accounts (46.3% of total average interest-bearing deposits in 2007, compared to 48.6% in 2006) to higher cost certificates of deposit (53.7% in 2007, compared to 51.4% in 2006). During the third quarter of 2007 the shift to higher cost deposits contributed to the decline in net interest margin.

The Corporation manages its risk associated with changes in interest rates through the techniques described in the “Market Risk” section of Management’s Discussion.

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 influenced by economic conditions and other factors, but can be managed through conservative underwriting and sound collection policies and procedures.

Non-performing assets increased $49.1 million, or 84.9%, from December 31, 2006 to September 30, 2007. The increase was due to: 1) the previously discussed repurchase of approximately $35 million of residential mortgage and home equity loans during the third quarter of 2007 ($20.8 million of which were classified as non-performing assets, net of reserves); and 2) general economic factors as opposed to specific risk concentrations within the Corporation’s loan portfolio.

Non-performing asset levels will continue to be impacted by general and regional economic conditions, as well as possible future loan repurchases, as detailed under the heading “Resource Mortgage” above.

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 and, historically, realized gains on sales of these equity securities have been a recurring component of the Corporation’s earnings.

More recently, declines in the value of the bank stock portfolio have resulted in a decline in investment securities gains. During the first nine months of 2007, the Corporation’s gains on investment securities decreased $3.2 million, or 58.8%. As of September 30, 2007, the Corporation’s bank stock portfolio had a net unrealized loss of $12.9 million, compared to a net unrealized loss of $100,000 at December 31, 2006. These declines in bank stock portfolio values have had a detrimental impact on the Corporation’s ability to realize gains during the three and nine months ended September 30, 2007.

Net interest income decreased $3.5 million, or 2.8%, to $122.4 million in 2007 from $125.9 million in 2006. The decrease in net interest margin was a result of lower interest income recoveries in 2007 ($3.3 million in 2006 and $396,000 in 2007). Also contributing to the decrease was a more pronounced increase in the costs of interest-bearing liabilities over the income received from interest-earning assets, resulting in a 23 basis point decrease in the net interest margin. The average cost of interest bearing liabilities increased 28 basis points (a 7.7% increase) over 2006, while the average fully taxable-equivalent (FTE) yield on interest-earning assets increased 5 basis points (a 0.7% increase) over 2006.

The following table provides a comparative average balance sheet and net interest income analysis for the third quarter of 2007 as compared to the same period in 2006. Interest income and yields are presented on an FTE basis, using a 35% Federal tax rate and statutory interest expense disallowances. The discussion following this table is based on these FTE amounts. All dollar amounts are in thousands.

The following table summarizes the changes in FTE interest income and expense due to changes in average balances (volume) and changes in rates:

Interest income increased $10.2 million, or 4.4%, due to the increase in average balances of interest-earning assets, which grew $492.1 million, or 3.7%.

The increase in average interest-earning assets was due to loan growth, which is summarized in the following table:

Loan growth was particularly strong in the commercial loan and commercial mortgage loan categories, which together increased $626.2 million, or 10.4%. Additional growth came from residential mortgage loans and home equity loans, which increased $115.5 million, or 5.5%, primarily due to growth in adjustable rate residential mortgage loans and partially due to repurchases of $18.0 million of residential mortgage loans and home equity loans during the third quarter of 2007.

Average investment securities decreased $110.7 million, or 3.8%, due to normal pay downs and maturities. The average yield on investment securities increased 26 basis points, or 5.8%, from 4.48% in 2006 to 4.74% in 2007.

The $10.2 million increase in interest income (FTE) was more than offset by an increase in interest expense of $13.2 million, or 12.7%, to $116.3 million in the third quarter of 2007 from $103.2 million in the third quarter of 2006. Interest expense increased $7.5 million as a result of a $568.5 million, or 5.1%, increase in average interest-bearing liabilities, while an increase of $5.7 million was realized from a 28 basis point, or 7.7%, increase in the average cost of interest-bearing liabilities.

The following table summarizes the changes in average deposits, by type:

The Corporation experienced a net decrease in noninterest-bearing and interest-bearing demand and savings accounts of $194.7 million, or 3.3%, as customers shifted from these accounts to higher yielding time deposits.

The following table summarizes the changes in average borrowings, by type: