M&T Bank - 10-Q quarterly report FY

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended March 31, 2004

or

Commission File Number 1-9861

M&T BANK CORPORATION

(716) 842-5445
(Registrant’s telephone number, including area code)

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 [x] No [  ]

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

Number of shares of the registrant’s Common Stock, $0.50 par value, outstanding as of the close of business on April 30, 2004: 118,533,428 shares.

M&T BANK CORPORATION

FORM 10-Q

For the Quarterly Period Ended March 31, 2004

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

M&T BANK CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET (Unaudited)

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M&T BANK CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INCOME (Unaudited)

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M&T BANK CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)

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M&T BANK CORPORATION AND SUBSIDIARIES

     CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

CONSOLIDATED SUMMARY OF CHANGES IN ALLOWANCE FOR CREDIT LOSSES (Unaudited)

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NOTES TO FINANCIAL STATEMENTS

1. Significant accounting policies

The consolidated financial statements of M&T Bank Corporation (“M&T”) and subsidiaries (“the Company”) were compiled in accordance with the accounting policies set forth in note 1 of Notes to Financial Statements included in the Company’s 2003 Annual Report, except as described below. In the opinion of management, all adjustments necessary for a fair presentation have been made and were all of a normal recurring nature.

2. Acquisition of Allfirst Financial Inc.

On April 1, 2003, M&T completed the acquisition of Allfirst Financial Inc. (“Allfirst”), a bank holding company headquartered in Baltimore, Maryland, from Allied Irish Banks, p.l.c. (“AIB”), Dublin, Ireland. Allfirst was merged with and into M&T on that date. Allfirst Bank, Allfirst’s primary banking subsidiary, was merged into Manufacturers and Traders Trust Company (“M&T Bank”), a wholly owned subsidiary of M&T, on that date. Allfirst Bank operated 269 banking offices in Maryland, Pennsylvania, Virginia and the District of Columbia at the date of acquisition. The results of operations acquired in the Allfirst transaction have been included in the Company’s financial results since April 1, 2003. Acquired assets on April 1, 2003 totaled $16 billion, including $10 billion of loans and leases, liabilities assumed aggregated $14 billion, including $11 billion of deposits, and $2 billion was added to stockholders’ equity. AIB received 26,700,000 shares of M&T common stock valued at $2 billion (based on the market value of M&T common stock at the time the terms of the merger were agreed to and announced by M&T and AIB in September 2002) and $886 million in cash in exchange for all outstanding Allfirst common shares. The Company incurred merger expenses related to systems conversions and other costs of integrating and conforming acquired operations with and into the Company during the three-month period ended March 31, 2003 of $5 million ($4 million after tax effect). Those merger-related expenses consisted largely of expenses for professional services and other temporary help fees associated with the planning of the conversion of systems and/or integration of operations; initial marketing and promotion expenses designed to introduce M&T Bank to customers of Allfirst; travel and relocation costs; and printing, supplies and other costs of commencing operations in new markets and offices. There were no similar expenses during the quarter ended March 31, 2004.

The acquisition of Allfirst represented a major geographic expansion by M&T and created a strong Mid-Atlantic banking franchise. Following the acquisition, the Company offers a broad range of products and services through its banking offices in six states and the District of Columbia. Management expects that M&T will benefit from greater geographic diversity and the benefits of scale associated with a larger company. As part of the purchase price allocation at April 1, 2003, M&T recorded $1.8 billion of goodwill, $136 million of core deposit intangible and $64 million of other intangible assets. The weighted-average amortization periods for newly acquired core deposit intangible and other intangible assets were eight years and seven years, respectively.

Disclosed below is certain pro forma information for 2003 as if Allfirst had been acquired on January 1, 2003. These results combine the historical results of Allfirst into the Company’s consolidated statement of income and, while certain adjustments were made for the estimated impact of purchase accounting adjustments and other acquisition-related activity, they are not necessarily indicative of what would have occurred had the acquisition taken place on the indicated date. In particular, expenses related to systems conversions and other costs of integration are included in the 2003 periods in which such costs were incurred and, additionally, the Company expects to achieve operating

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NOTES TO FINANCIAL STATEMENTS, CONTINUED

2. Acquisition of Allfirst Financial Inc., continued

cost savings as a result of the acquisition which are not reflected in the pro forma amounts presented below.

3. Earnings per share

The computations of basic earnings per share follow:

The computations of diluted earnings per share follow:

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NOTES TO FINANCIAL STATEMENTS, CONTINUED

4. Comprehensive income

The following table displays the components of other comprehensive income:

     Accumulated other comprehensive income, net consisted of unrealized gains (losses) as follows:

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NOTES TO FINANCIAL STATEMENTS, CONTINUED

5. Borrowings

In 1997, M&T Capital Trust I (“Trust I”), M&T Capital Trust II (“Trust II”), and M&T Capital Trust III (“Trust III”) issued $310 million of fixed rate preferred capital securities. As a result of the Allfirst acquisition, M&T assumed responsibility for $300 million of similar preferred capital securities previously issued by special-purpose entities formed by Allfirst consisting of $150 million of floating rate preferred capital securities issued by First Maryland Capital I (“Trust IV”) in December 1996 and $150 million of floating rate preferred capital securities issued by First Maryland Capital II (“Trust V”) in January 1997. The distribution rates on the preferred capital securities of Trust IV and Trust V adjust quarterly based on changes in the three-month London Interbank Offered Rate (“LIBOR”) and were 2.12% and 1.98%, respectively, at March 31, 2004 and 2.15% and 2.01%, respectively, at December 31, 2003. Trust I, Trust II, Trust III, Trust IV and Trust V are referred to herein collectively as the “Trusts.”

Other than the following payment terms (and the redemption terms described below), the preferred capital securities issued by the Trusts (“Capital Securities”) are substantially identical in all material respects:

The common securities of each Trust (“Common Securities”) are wholly owned by M&T and are the only class of each Trust’s securities possessing general voting powers. The Capital Securities represent preferred undivided interests in the assets of the corresponding Trust. Under the Federal Reserve Board’s current risk-based capital guidelines, the Capital Securities are includable in M&T’s Tier 1 capital.

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NOTES TO FINANCIAL STATEMENTS, CONTINUED

5. Borrowings, continued

The proceeds from the issuances of the Capital Securities and Common Securities were used by the Trusts to purchase junior subordinated deferrable interest debentures (“Junior Subordinated Debentures”) of M&T as follows:

The Junior Subordinated Debentures represent the sole assets of each Trust and payments under the Junior Subordinated Debentures are the sole source of cash flow for each Trust. The financial statement carrying values of junior subordinated debentures associated with preferred capital securities of Trust III, Trust IV and Trust V at March 31, 2004 and December 31, 2003 include the unamortized portions of purchase accounting adjustments to reflect estimated fair value as of the date of M&T’s acquisition of the common securities of each respective trust. The interest rates payable on the Junior Subordinated Debentures of Trust IV and Trust V were 2.12% and 1.98%, respectively, at March 31, 2004 and 2.15% and 2.01%, respectively, at December 31, 2003.

Holders of the Capital Securities receive preferential cumulative cash distributions on each distribution date at the stated distribution rate unless M&T exercises its right to extend the payment of interest on the Junior Subordinated Debentures for up to ten semi-annual periods (in the case of Trust I, Trust II and Trust III) or twenty quarterly periods (in the case of Trust IV and Trust V), in which case payment of distributions on the respective Capital Securities will be deferred for comparable periods. During an extended interest period, M&T may not pay dividends or distributions on, or repurchase, redeem or acquire any shares of its capital stock. The agreements governing the Capital Securities, in the aggregate, provide a full, irrevocable and unconditional guarantee by M&T of the payment of distributions on, the redemption of, and any liquidation distribution with respect to the Capital Securities. The obligations under such guarantee and the Capital Securities are subordinate and junior in right of payment to all senior indebtedness of M&T.

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NOTES TO FINANCIAL STATEMENTS, CONTINUED

5. Borrowings, continued

The Capital Securities will remain outstanding until the Junior Subordinated Debentures are repaid at maturity, are redeemed prior to maturity or are distributed in liquidation to the Trusts. The Capital Securities are mandatorily redeemable in whole, but not in part, upon repayment at the stated maturity dates of the Junior Subordinated Debentures or the earlier redemption of the Junior Subordinated Debentures in whole upon the occurrence of one or more events (“Events”) set forth in the indentures relating to the Capital Securities, and in whole or in part at any time after the stated optional redemption dates (January 15, 2007 in the case of Trust IV, February 1, 2007 in the case of Trust I, Trust III and Trust V, and June 1, 2007 in the case of Trust II) contemporaneously with the optional redemption of the related Junior Subordinated Debentures in whole or in part. The Junior Subordinated Debentures are redeemable prior to their stated maturity dates at M&T’s option (i) on or after the stated optional redemption dates, in whole at any time or in part from time to time, or (ii) in whole, but not in part, at any time within 90 days following the occurrence and during the continuation of one or more of the Events, in each case subject to possible regulatory approval. The redemption price of the Capital Securities and the related Junior Subordinated Debentures upon early redemption will be expressed as a percentage of the liquidation amount plus accumulated but unpaid distributions. In the case of Trust I, such percentage adjusts annually and ranges from 104.117% at February 1, 2007 to 100.412% for the annual period ending January 31, 2017, after which the percentage is 100%, subject to a make-whole amount if the early redemption occurs prior to February 1, 2007. In the case of Trust II, such percentage adjusts annually and ranges from 104.139% at June 1, 2007 to 100.414% for the annual period ending May 31, 2017, after which the percentage is 100%, subject to a make-whole amount if the early redemption occurs prior to June 1, 2007. In the case of Trust III, such percentage adjusts annually and ranges from 104.625% at February 1, 2007 to 100.463% for the annual period ending January 31, 2017, after which the percentage is 100%, subject to a make-whole amount if the early redemption occurs prior to February 1, 2007. In the case of Trust IV and Trust V, the redemption price upon early redemption will be equal to 100% of the principal amount to be redeemed plus any accrued but unpaid distributions to the redemption date.

As a result of the Allfirst acquisition, M&T also assumed responsibility for $100 million of Floating Rate Non-Cumulative Subordinated Trust Enhanced Securities (“SKATES”) that were issued by Allfirst Preferred Capital Trust (“Allfirst Capital Trust”). Allfirst Capital Trust is a Delaware business trust that was formed in June 1999 for the exclusive purposes of (i) issuing the SKATES and common securities, (ii) purchasing Asset Preferred Securities issued by Allfirst Preferred Asset Trust (“Allfirst Asset Trust”) and (iii) engaging in only those other activities necessary or incidental thereto. M&T holds 100% of the common securities of Allfirst Capital Trust. Allfirst Asset Trust is a Delaware business trust that was formed in June 1999 for the exclusive purposes of (i) issuing Asset Preferred Securities and common securities, (ii) investing the gross proceeds of the Asset Preferred Securities in junior subordinated debentures originally issued by Allfirst (and assumed by M&T as part of its acquisition of Allfirst on April 1, 2003) and other permitted investments and (iii) engaging in only those other activities necessary or incidental thereto. M&T holds 100% of the common securities of Allfirst Asset Trust and Allfirst Capital Trust holds 100% of the Asset Preferred Securities of Allfirst Asset Trust. M&T has outstanding $105.3 million aggregate liquidation amount Floating Rate Junior Subordinated Debentures due July 15, 2029 that were originally issued by Allfirst and are payable to Allfirst Asset Trust. The interest rates payable on such debentures were 2.55% at March 31, 2004 and 2.58% at December 31, 2003.

Distributions on the SKATES are non-cumulative. The distribution rate on the SKATES and on the Floating Rate Junior Subordinated Debentures is a rate per annum of three month LIBOR plus 1.50% reset quarterly two business days prior

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NOTES TO FINANCIAL STATEMENTS, CONTINUED

5. Borrowings, continued

to the distribution dates of January 15, April 15, July 15, and October 15 in each year. Distributions on the SKATES will be paid if, as and when Allfirst Capital Trust has funds available for payment. The SKATES are subject to mandatory redemption if the Asset Preferred Securities of Allfirst Asset Trust are redeemed. Allfirst Asset Trust will redeem the Asset Preferred Securities if the junior subordinated debentures of M&T held by Allfirst Asset Trust are redeemed. M&T may redeem such junior subordinated debentures, in whole or in part, at any time on or after July 15, 2009, subject to regulatory approval. Allfirst Asset Trust will redeem the Asset Preferred Securities at par plus accrued and unpaid distributions from the last distribution payment date. M&T has guaranteed, on a subordinated basis, the payment in full of all distributions and other payments on the SKATES and on the Asset Preferred Securities to the extent that Allfirst Capital Trust and Allfirst Asset Trust, respectively, have funds legally available. Under the Federal Reserve Board’s current risk-based capital guidelines, the SKATES are includable in M&T’s Tier I Capital.

Effective December 31, 2003, the Company applied new accounting provisions promulgated by the Financial Accounting Standards Board (“FASB”) and removed the Trusts and Allfirst Asset Trust from the Company’s consolidated balance sheet. Accordingly, at March 31, 2004 and December 31, 2003, the Company included the Junior Subordinated Debentures payable to the Trusts and the Floating Rate Junior Subordinated Debentures payable to the Allfirst Asset Trust as long-term borrowings in its consolidated balance sheet. Prior to December 31, 2003 the Company included the preferred capital securities of the Trusts and the SKATES issued by Allfirst Capital Trust in its consolidated balance sheet as long-term borrowings, with accumulated distributions on such securities included in interest expense. That change in financial statement presentation had no economic impact on the Company and no material or substantive impact on the Company’s consolidated financial statements.

6. Segment information

Reportable segments have been determined based upon the Company’s internal profitability reporting system, which is organized by strategic business units. Certain strategic business units have been combined for segment information reporting purposes where the nature of the products and services, the type of customer and the distribution of those products and services are similar. The reportable segments are Commercial Banking, Commercial Real Estate, Discretionary Portfolio, Residential Mortgage Banking and Retail Banking.

The financial information of the Company’s segments was compiled utilizing the accounting policies described in note 21 to the Company’s consolidated financial statements as of and for the year ended December 31, 2003. The management accounting policies and processes utilized in compiling segment financial information are highly subjective and, unlike financial accounting, are not based on authoritative guidance similar to generally accepted accounting principles. As a result, the financial information of the reported segments is not necessarily comparable with similar information reported by other financial institutions. As also described in note 21 to the Company’s 2003 consolidated financial statements, neither goodwill nor core deposit and other intangible assets (and the amortization charges associated with such assets) resulting from acquisitions of financial institutions have been allocated to the Company’s reportable segments, but are included in the “All Other” category. The Company has, however, assigned such intangible assets to business units for purposes of

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NOTES TO FINANCIAL STATEMENTS, CONTINUED

6. Segment information, continued

testing for impairment. Information about the Company’s segments is presented in the following table:

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NOTES TO FINANCIAL STATEMENTS, CONTINUED

6. Segment information, continued

7. Commitments and contingencies

In the normal course of business, various commitments and contingent liabilities are outstanding. The following table presents the Company’s significant commitments. Certain of these commitments are not included in the Company’s consolidated balance sheet.

Commitments to extend credit are agreements to lend to customers, generally having fixed expiration dates or other termination clauses that may require payment of a fee. Standby and commercial letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party, whereas commercial letters of credit are issued to facilitate commerce and typically result in the commitment being funded when the underlying transaction is consummated between the customer and third party. The credit risk associated with commitments to extend credit and standby and commercial letters of credit is essentially the same as that involved with extending loans to customers and is subject to normal credit policies. Collateral may be obtained based on management’s assessment of the customer’s creditworthiness.

Financial guarantees and indemnification contracts are oftentimes similar to standby letters of credit and include mandatory purchase agreements issued to ensure that customer obligations are fulfilled, recourse obligations associated with sold loans, and other guarantees of customer performance or compliance with designated rules and regulations. Included in financial guarantees and indemnification contracts are loan principal amounts sold with recourse which totaled $842 million at March 31, 2004 and December 31, 2003.

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NOTES TO FINANCIAL STATEMENTS, CONTINUED

7. Commitments and contingencies, continued

Since many loan commitments, standby letters of credit, and guarantees and indemnification contracts expire without being funded in whole or in part, the contract amounts are not necessarily indicative of future cash flows.

The Company utilizes commitments to sell real estate loans to hedge exposure to changes in the fair value of real estate loans held for sale. Such commitments are considered derivatives in accordance with SFAS No. 133 and along with commitments to originate real estate loans to be held for sale and hedged real estate loans held for sale are now generally recorded in the consolidated balance sheet at estimated fair market value. However, in accordance with Staff Accounting Bulletin (“SAB”) No. 105, “Application of Accounting Principles to Loan Commitments,” issued by the United States Securities and Exchange Commission, effective April 1, 2004, value ascribable to cash flows that will be realized in connection with loan servicing activities will not be included in the determination of fair value of loans held for sale or commitments to originate loans for sale. Value ascribable to that portion of cash flows will be recognized at the time the underlying mortgage loans are sold. As a result, the Company expects that there will be a one-time deferral of mortgage banking revenues from the second quarter of 2004 to the third quarter of 2004. Had SAB No. 105 been effective at March 31, 2004, recognition of approximately $6 million of mortgage banking revenues would have been deferred from the first quarter to the second quarter of 2004. Moreover, had the provisions of SAB No. 105 been effective as of December 31, 2003, the Company estimates that mortgage banking revenues in the first quarter of 2004 would not have differed significantly from the amount of revenues actually reported in that quarter.

The Company entered an agreement in 2003 with the Baltimore Ravens of the National Football League whereby the Company obtained the naming rights to a football stadium in Baltimore, Maryland for a fifteen year term. Under the agreement, the Company paid $3 million in 2003 and is obligated to pay $3 million in 2004, $5 million per year from 2005 through 2013, and $6 million per year from 2014 through 2017.

The Company also has commitments under long-term operating leases.

M&T and its subsidiaries are subject in the normal course of business to various pending and threatened legal proceedings in which claims for monetary damages are asserted. Management, after consultation with legal counsel, does not anticipate that the aggregate ultimate liability arising out of litigation pending against M&T or its subsidiaries will be material to the Company’s consolidated financial position, but at the present time is not in a position to determine whether such litigation will have a material adverse effect on the Company’s consolidated results of operations in any future reporting period.

8. Pension plans and other postretirement benefits

The Company provides defined benefit pension and other postretirement benefits (including health care and life insurance benefits) to qualified retired employees. Net periodic benefit cost consisted of the following:

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

M&T Bank Corporation (“M&T”) reported net income in the first quarter of 2004 of $159 million or $1.30 of diluted earnings per common share, increases of 37% and 6%, respectively, from the first quarter of 2003 when net income was $117 million or $1.23 of diluted earnings per common share. During the fourth quarter of 2003, net income was $167 million or $1.35 of diluted earnings per common share. Basic earnings per common share were $1.33 in the recently completed quarter, compared with $1.26 in the first quarter of 2003 and $1.39 in 2003’s final quarter. The after-tax impact of merger-related expenses associated with M&T’s acquisition activity, as discussed below, was $4 million or $.04 of diluted and basic earnings per share in 2003’s initial quarter and $2 million or $.01 of diluted and basic earnings per share in the fourth quarter of 2003. There were no similar expenses in the first quarter of 2004.

     The annualized rate of return on average total assets for M&T and its consolidated subsidiaries (“the Company”) in the first quarter of 2004 was 1.29%, compared with 1.43% in the year-earlier quarter and 1.35% in the fourth quarter of 2003. The annualized rate of return on average common stockholders’ equity was 11.19% in the recent quarter, compared with 14.46% and 11.77% in the first and fourth quarters of 2003, respectively. Excluding the impact of merger-related expenses, the annualized returns on average assets and average common equity were 1.47% and 14.91%, respectively, for 2003’s first quarter and 1.36% and 11.89%, respectively, in the final 2003 quarter.

     On April 1, 2003, M&T completed the acquisition of Allfirst Financial Inc. (“Allfirst”), a bank holding company headquartered in Baltimore, Maryland, from Allied Irish Banks, p.l.c. (“AIB”), Dublin, Ireland. Allfirst Bank, Allfirst’s primary banking subsidiary, was merged into Manufacturers and Traders Trust Company (“M&T Bank”), a wholly owned bank subsidiary of M&T, on that date. Allfirst Bank operated 269 banking offices in Maryland, Pennsylvania, Virginia and the District of Columbia at the date of acquisition. AIB received 26,700,000 shares of M&T common stock and $886 million in cash in exchange for all outstanding Allfirst common shares. Immediately after the completion of the acquisition, AIB owned approximately 22.5% of the outstanding shares of M&T’s common stock. A condensed balance sheet for the Company as of the opening of business on April 1, 2003, which includes a summary of assets acquired and liabilities assumed from Allfirst, is presented herein.

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     Merger-related expenses associated with the Allfirst acquisition incurred during the quarters ended March 31 and December 31, 2003 totaled $5 million ($4 million after tax effect) and $3 million ($2 million after tax effect), respectively. Such expenses were for professional services and temporary help associated with the conversion of systems and/or integration of operations; initial marketing and promotion expenses designed to introduce M&T Bank to Allfirst’s customers; travel and relocation costs; and printing, supplies and other costs of commencing operations in new markets and offices. There were no unpaid merger-related expenses as of March 31, 2004. In accordance with generally accepted accounting principles (“GAAP”), included in the determination of goodwill associated with the Allfirst merger were charges totaling $29 million, net of applicable income taxes ($48 million before tax effect), for severance costs for former Allfirst employees; investment banking and other professional fees; and termination of Allfirst contracts for various services. As of March 31, 2004, the remaining unpaid portion of such charges totaled $8 million and related largely to severance payments yet to be paid to former employees.

     In anticipation of the Allfirst acquisition, M&T Bank issued $400 million of subordinated notes on March 31, 2003 to fund a portion of the cash consideration paid to AIB and to maintain appropriate regulatory capital ratios. The subordinated notes are included in regulatory capital of M&T and M&T Bank. The notes pay interest semi-annually on April 1 and October 1. The interest rate is fixed at 3.85% through March 31, 2008, with a floating rate payable from April 1, 2008 through the maturity date based on the then applicable U.S. dollar three-month London Interbank Offered Rate (“LIBOR”) plus 1.50%. The notes will mature on April 1, 2013. Beginning on April 1, 2008, M&T Bank may, at its option and subject to prior regulatory approval, redeem some or all of the subordinated notes on any interest payment date at a redemption price equal to 100% of the redeemed principal, plus any accrued but unpaid interest.

Supplemental Reporting of Non-GAAP Results of Operations

M&T has accounted for substantially all of its business combinations using the purchase method of accounting. As a result, the Company had recorded intangible assets consisting of goodwill and core deposit and other intangible assets totaling $3.1 billion at March 31, 2004 and December 31, 2003, and $1.2

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billion at March 31, 2003. Included in such intangible assets at March 31, 2004 and December 31, 2003 was goodwill of $2.9 billion, up from $1.1 billion at March 31, 2003 due to the Allfirst acquisition. Amortization of core deposit and other intangible assets, after tax effect, was $13 million ($.11 per diluted share) during each of the first quarter of 2004 and fourth quarter of 2003, compared with $7 million ($.07 per diluted share) in the first quarter of 2003. The higher levels of such amortization when compared with 2003’s first quarter were due to the impact of core deposit and other intangible assets recorded as part of the Allfirst transaction.

     Since 1998, M&T has consistently provided supplemental reporting of its results on a “net operating” or “tangible” basis, from which M&T excludes the after-tax effect of amortization of core deposit and other intangible assets (and the related goodwill, core deposit intangible and other intangible asset balances, net of applicable deferred tax amounts) and expenses associated with merging acquired operations into the Company, since such expenses are considered by management to be “nonoperating” in nature. Although “net operating income” as defined by M&T is not a GAAP measure, M&T’s management believes that this information helps investors understand the effect of acquisition activity in reported results.

     Net operating income rose 36% to $172 million in the first quarter of 2004 from $127 million in the corresponding quarter of 2003. Diluted net operating earnings per share for the recent quarter were $1.41, an increase of 5% from $1.34 in the first quarter of 2003. Net operating income and diluted net operating earnings per share were $182 million and $1.47, respectively, in the fourth quarter of 2003.

     Net operating income in 2004’s first quarter represented an annualized rate of return on average tangible assets of 1.48%, compared with 1.62% and 1.57% in the first and fourth quarters of 2003, respectively. Net operating income expressed as an annualized return on average tangible common equity was 26.02% in the first quarter of 2004, compared with 24.68% in the year-earlier quarter and 28.33% in the fourth quarter of 2003. Including the effect of merger-related expenses, the annualized net operating returns on average tangible assets and average tangible common stockholders’ equity for the first quarter of 2003 were 1.57% and 23.99%, respectively, and for the final 2003 quarter were 1.55% and 28.07%, respectively.

     Reconciliations of GAAP results with non-GAAP results are provided in table 2.

Taxable-equivalent Net Interest Income

Taxable-equivalent net interest income increased 33% to $424 million in the first quarter of 2004 from $320 million in the corresponding quarter of 2003. Taxable-equivalent net interest income was $426 million in the fourth quarter of 2003. The improvement in the recent quarter as compared with 2003’s first quarter reflects a $13.4 billion, or 45%, rise in average earning assets, offset, in part, by a narrowing of the Company’s net interest margin, or taxable-equivalent net interest income expressed as an annualized percentage of average earning assets. Average loans and leases increased $10.1 billion, or 39%, to $35.8 billion in the initial 2004 quarter from $25.8 billion in the corresponding quarter of 2003, but were down 1% from the $36.4 billion average in 2003’s final quarter. The most significant factor for the higher loan balances in the recently completed quarter as compared with the first quarter of 2003 was the impact of the $10.3 billion of loans obtained in the Allfirst acquisition. Such acquired loans were comprised of approximately $4.5 billion of commercial loans and leases (including $314 million of leveraged leases and $230 million of loans to foreign borrowers), $2.5 billion of commercial real estate loans, $383 million of residential real estate loans and $2.9 billion of consumer loans and leases. Excluding loans attributable to the Allfirst franchise, average outstanding commercial loans and commercial real estate loans in the recent quarter were higher by 5% and 3%, respectively, as compared with the first quarter of 2003. Although corporate profits have been

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reported at high levels, demand for commercial and industrial loans has remained lower than expected. Consumer loans in the non-Allfirst regions in the first quarter of 2004 grew at a 17% rate over the year-earlier period, largely due to increases in the automobile loan portfolio. The consumer real estate loan portfolio decreased 12% from the first quarter of 2003, due largely to the impact of two fourth quarter 2003 transactions in which M&T converted $1.3 billion of such loans into mortgage-backed securities. The decrease in average loans outstanding from the fourth quarter of 2003 was also largely attributable to the impact of those securitization transactions. Excluding loans associated with the Allfirst franchise, the Company experienced modest growth in the commercial loan and commercial real estate loan portfolios in the recent quarter as compared with 2003’s final quarter, while consumer loans grew at an annualized rate of 9%. More than offsetting these portfolio increases was the full-period impact of the fourth quarter securitization transactions. In the portfolios acquired from Allfirst, average loans continued to decline, largely due to the Company’s decision to de-emphasize certain specialized lending businesses and due to prepayment activity in a discontinued home equity loan product. The rate of decline in the acquired portfolios has, however, slowed from earlier quarters. The accompanying table summarizes quarterly changes in the major components of the loan and lease portfolio.

AVERAGE LOANS AND LEASES
(net of unearned discount)
Dollars in millions

     Investment securities averaged $7.5 billion during the first quarter of 2004, compared with $3.6 billion in the year-earlier quarter and $6.2 billion in the fourth quarter of 2003. The higher level of investment securities in the recently completed quarter included the impact of investment securities obtained in the Allfirst acquisition, the fourth quarter 2003 residential real estate loan securitizations already noted, and net purchases of securities in 2003 and 2004. The investment securities portfolio is largely comprised of residential and commercial mortgage-backed securities and collateralized mortgage obligations, debt securities issued by municipalities, debt and preferred equity securities issued by government-sponsored agencies and certain financial institutions, and shorter-term U.S. Treasury notes. When purchasing investment securities, the Company considers its overall interest-rate risk profile as well as the adequacy of expected returns relative to risks assumed, including prepayments. In managing its investment securities portfolio, the Company occasionally sells investment securities as a result of changes in interest rates and spreads, actual or anticipated prepayments, or credit risk associated with a particular security, or as a result of restructuring its investment securities portfolio following completion of a business combination.

     Money-market assets, which are comprised of interest-earning deposits at banks, interest-earning trading account assets, federal funds sold and agreements to resell securities, averaged $85 million in the recently completed quarter, compared with $577 million and $99 million in the first and fourth quarters of 2003, respectively. The amount of investment securities and money-market assets held by the Company are influenced by such factors as demand for loans, which generally yield more than investment securities and money-market assets, ongoing repayments, the levels of deposits, and management of balance sheet size and resulting capital ratios.

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     As a result of the changes described herein, average earning assets increased 45% to $43.4 billion in the first quarter of 2004 from $30.0 billion in the year-earlier quarter. Average earning assets were $42.7 billion in the fourth quarter of 2003.

     Core deposits represent the most significant source of funding for the Company and are comprised of noninterest-bearing deposits, interest-bearing transaction accounts, nonbrokered savings deposits and nonbrokered domestic time deposits under $100,000. The Company’s branch network is its principal source of core deposits, which generally carry lower interest rates than wholesale funds of comparable maturities. Core deposits include certificates of deposit under $100,000 generated on a nationwide basis by M&T Bank, National Association (“M&T Bank, N.A.”), a wholly owned bank subsidiary of M&T. Average core deposits were $27.9 billion in the first quarter of 2004, compared with $17.8 billion in the year earlier quarter and $28.3 billion in 2003’s fourth quarter. Core deposits assumed in connection with the Allfirst acquisition totaled $10.7 billion on April 1, 2003. The following table provides an analysis of quarterly changes in the components of average core deposits.

AVERAGE CORE DEPOSITS

     The Company also obtains funding through domestic time deposits of $100,000 or more, deposits originated through the Company’s offshore branch office, and brokered deposits. Domestic time deposits over $100,000, excluding brokered certificates of deposit, averaged $1.2 billion in the initial 2004 quarter and fourth quarter of 2003, compared with $1.0 billion during the first quarter of 2003. Offshore branch deposits, primarily comprised of accounts with balances of $100,000 or more, averaged $2.8 billion, $1.1 billion and $2.4 billion for the three-month periods ended March 31, 2004, March 31, 2003 and December 31, 2003, respectively. Brokered time deposits averaged $854 million during the first quarter of 2004, compared with $1.2 billion and $412 million in the first and fourth quarters of 2003, respectively. At March 31, 2004, brokered time deposits totaled $1.3 billion and had a weighted-average remaining term to maturity of 18 months. Certain of these brokered time deposits have provisions that allow early redemption. In connection with the Company’s management of interest rate risk, interest rate swap agreements have been entered into under which the Company receives a fixed rate of interest and pays a variable rate and that have notional amounts and terms substantially similar to the amounts and terms of $100 million of brokered time deposits. The Company also had brokered money-market deposit accounts which averaged $59 million during the first quarters of 2004 and 2003, and $60 million in the fourth quarter of 2003. Offshore branch deposits and brokered deposits have been used by the Company as an alternative to short-term borrowings. Additional amounts of offshore branch deposits or brokered deposits may be solicited in the future depending on market conditions, including demand by customers and other investors for those deposits, and the cost of funds available from alternative sources at the time.

     The Company also uses borrowings from banks, securities dealers, the Federal Home Loan Bank of New York, Pittsburgh and Atlanta (together, the “FHLB”), and others as sources of funding. Short-term borrowings averaged $4.8 billion in the recent quarter, compared with $3.5 billion and $4.2 billion in the first and fourth quarters of 2003, respectively. Amounts borrowed from the FHLB and included in short-term borrowings averaged $572 million in the first quarter of 2003, while there were no such short-term borrowings in the fourth quarter of 2003 or in the initial 2004 quarter. Also

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included in short-term borrowings is a $500 million revolving asset-backed structured borrowing secured by automobile loans that were transferred to M&T Auto Receivables I, LLC, a special purpose subsidiary of M&T Bank formed in November 2002. The subsidiary, the loans and the borrowings are included in the consolidated financial statements of the Company. The remaining short-term borrowings were predominantly comprised of unsecured federal funds borrowings, which generally mature daily. Federal funds borrowings averaged $3.9 billion in the recent quarter, compared with $2.4 billion and $3.3 billion in the first and fourth quarter of 2003, respectively.

     The average balance of long-term borrowings was $5.6 billion in the first quarter of 2004, compared with $4.8 billion in the year-earlier quarter and $5.9 billion in the fourth quarter of 2003. Included in average long-term borrowings were amounts borrowed from the FHLB of $3.1 billion in the initial quarter of 2004, and $3.8 billion and $3.6 billion in the first and fourth quarters of 2003, respectively, and subordinated capital notes of $1.3 billion in the two most recent quarters and $604 million in the first quarter 2003. Subordinated capital notes obtained in the Allfirst acquisition on April 1, 2003 averaged $330 million in the first quarter of 2004 and $332 million in the final 2003 quarter. As described in note 5 of Notes to Financial Statements, as of December 31, 2003 the Company applied new accounting provisions promulgated by the Financial Accounting Standards Board (“FASB”) and removed from its consolidated balance sheet the trusts that had issued trust preferred securities. That change had no economic impact on the Company and no material or substantive impact on the Company’s financial statements. Trust preferred securities included in average long-term borrowings totaled $318 million in the first quarter of 2003 and $686 million in the fourth quarter of 2003. Junior subordinated debentures associated with trust preferred securities that were included in average long-term borrowings in 2004’s initial quarter were $710 million. Junior subordinated debentures associated with trust preferred securities assumed in the Allfirst acquisition averaged $383 million in the recent quarter. Trust preferred securities assumed in the acquisition of Allfirst averaged $372 million in the fourth quarter of 2003. Information regarding trust preferred securities and the related junior subordinated debentures is provided in note 5 of Notes to Financial Statements. As described later, certain interest rate swap agreements have been entered into by the Company as part of its management of interest rate risk relating to long-term borrowings.

     In addition to changes in the composition of the Company’s earning assets and interest-bearing liabilities, changes in interest rates and spreads can impact net interest income. Net interest spread, or the difference between the taxable-equivalent yield on earning assets and the rate paid on interest-bearing liabilities, was 3.67% in the first quarter of 2004 and 4.05% in the year-earlier quarter. The yield on earning assets during the recent quarter decreased 84 basis points (hundredths of one percent) to 5.10% from 5.94%, while the rate paid on interest-bearing liabilities decreased 46 basis points to 1.43% from 1.89%. In the final quarter of 2003, the net interest spread was 3.68%, the yield on earning assets was 5.16% and the rate paid on interest-bearing liabilities was 1.48%. Lower yielding portfolios of loans and investment securities obtained in the Allfirst merger contributed to the reduced yields on earning assets in the two most recent quarters as compared with the first quarter of 2003 and were the leading cause for the lower net interest spread in those quarters. The declines in interest rates earned and paid also reflect generally lower market interest rates.

     Net interest-free funds consist largely of noninterest-bearing demand deposits and stockholders’ equity, partially offset by bank owned life insurance and non-earning assets, including goodwill and core deposit and other intangible assets. Average net interest-free funds totaled $7.8 billion in the first quarter of 2004, compared with $4.3 billion and $7.9 billion in the first and fourth quarters of 2003, respectively. The increases in average net interest-free funds in the first 2004 quarter and the fourth quarter of 2003 as compared with the initial 2003 quarter were due largely to the impact of the Allfirst acquisition. Goodwill and core deposit and other intangible assets averaged $3.1 billion during the first quarter of 2004, $3.2 billion in

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the fourth quarter of 2003 and $1.2 billion in the first quarter of 2003. Average goodwill and core deposit and other intangible assets resulting from the Allfirst transaction totaled $2 billion in the recently completed quarter and in the fourth quarter of 2003. The cash surrender value of bank owned life insurance averaged $956 million and $624 million in the first quarter of 2004 and 2003, respectively, and $944 million in the fourth quarter of 2003. The cash surrender value of bank owned life insurance obtained on April 1, 2003 in conjunction with the Allfirst acquisition averaged $294 million and $290 million in the two most recent quarters. Tax-exempt income earned from increases in the cash surrender value of bank owned life insurance and benefits received are not included in interest income, but rather are recorded in “other revenues from operations.”

     The contribution of net interest-free funds to net interest margin was ..25% in the recent quarter, compared with .27% in the year-earlier quarter and .28% in 2003’s fourth quarter. The decline in the contribution to net interest margin ascribed to net interest-free funds in the recent quarter as compared with the first quarter of 2003 resulted largely from the impact of lower interest rates on interest-bearing liabilities used to value such contribution, while the decreased contribution from the fourth quarter of 2003 was largely due to a $121 million decline in net interest-free funds.

     Reflecting the changes described herein, the Company’s net interest margin was 3.92% in 2004’s initial quarter, down from 4.32% in the comparable quarter of 2003 and 3.96% in the fourth quarter of 2003. As noted earlier, lower yielding portfolios of loans and investment securities obtained in the Allfirst acquisition contributed to the lower net interest margin in the two most recent quarters as compared with the first quarter of 2003. The continuing low interest rate environment has resulted in a narrowing of the net interest margin in recent quarters, as the yields on earning assets (particularly loan yields due to repricing) have declined more than rates paid on interest-bearing liabilities. The net interest margin has declined in each quarter subsequent to the first quarter of 2003, and the recent quarter’s net interest margin was the lowest earned by the Company since the fourth quarter of 1998.

     In managing interest rate risk, the Company utilizes interest rate swap agreements to modify the repricing characteristics of certain portions of its portfolios of earning assets and interest-bearing liabilities. Periodic settlement amounts arising from these agreements are generally reflected in either the yields earned on assets or, as appropriate, the rates paid on interest-bearing liabilities. The notional amount of interest rate swap agreements entered into for interest rate risk management purposes was $675 million as of March 31, 2004, $685 million as of December 31, 2003 and $355 million as of March 31, 2003. In general, under the terms of these swap agreements, the Company receives payments based on the outstanding notional amount of the swaps at fixed rates of interest and makes payments at variable rates. However, under the terms of a $100 million swap agreement that had been in effect at March 31, 2003 and that had been designated as a cash flow hedge, the Company paid a fixed rate of interest and received a variable rate.

     As of March 31, 2004, all of the Company’s interest rate swap agreements entered into for risk management purposes had been designated as fair value hedges. In a fair value hedge, the fair value of the derivative (the interest rate swap agreement) and changes in the fair value of the hedged item are recorded in the Company’s consolidated balance sheet with the corresponding gain or loss recognized in current earnings. The difference between changes in the fair value of the interest rate swap agreements and the hedged items represents hedge ineffectiveness and is recorded in “other revenues from operations” in the Company’s consolidated statement of income. In a cash flow hedge, the effective portion of the derivative’s gain or loss is initially reported as a component of other comprehensive income and subsequently reclassified into earnings when the forecasted transaction affects earnings. The ineffective portion of the gain or loss is reported in “other revenues from operations” immediately. The amounts of hedge ineffectiveness of both fair value and cash flow hedges used for interest rate risk management

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purposes recognized during the quarters ended March 31, 2004 and 2003 and the quarter ended December 31, 2003 were not material to the Company’s results of operations. The estimated fair values of interest rate swap agreements designated as fair value hedges was a gain of approximately $15 million at March 31, 2004, compared with a gain of $7 million at March 31, 2003 and a loss of $1 million at December 31, 2003. The fair values of such swap agreements were substantially offset by changes in the fair values of the hedged items. The estimated fair value of the interest rate swap agreement designated as a cash flow hedge at March 31, 2003 was a loss of approximately $690 thousand. Net of applicable income taxes, such loss was approximately $421 thousand and was included in “accumulated other comprehensive income, net” in the Company’s consolidated balance sheet as of March 31, 2003. The changes in the fair values of the interest rate swap agreements and the hedged items result from the effects of changing interest rates.

     The weighted average rates to be received and paid under interest rate swap agreements currently in effect were 6.99% and 4.04%, respectively, at March 31, 2004. The average notional amounts of interest rate swap agreements and the related effect on net interest income and margin, and the weighted-average rate paid or received on those swaps are presented in the accompanying table.

INTEREST RATE SWAP AGREEMENTS

     As a financial intermediary, the Company is exposed to various risks, including liquidity and market risk. Liquidity refers to the Company’s ability to ensure that sufficient cash flow and liquid assets are available to satisfy current and future obligations, including demands for loans and deposit withdrawals, operating costs, and other corporate purposes. Liquidity risk arises whenever the maturities of financial instruments included in assets and liabilities differ. Deposits and borrowings, maturities of money-market assets and investment securities, repayments of loans and investment securities, and cash generated from operations, such as fees collected for services, provide the Company with sources of liquidity. M&T’s banking subsidiaries have access to additional funding sources through FHLB borrowings, lines of credit with the Federal Reserve Bank of New York, and other available borrowing facilities. M&T Bank has also obtained funding through issuances of subordinated capital notes and through the $500 million revolving asset-backed borrowing noted earlier. Informal and sometimes reciprocal sources of funding are also available to M&T Bank through various arrangements for unsecured short-term borrowings from a wide group of banks and other financial institutions. Short-term federal funds borrowings aggregated $4.0 billion, $3.5 billion and $1.9 billion at March 31, 2004, December 31, 2003 and March 31, 2003, respectively. In general, these borrowings were unsecured and matured on the following business day.

     Should the Company experience a substantial deterioration in its financial condition or its debt ratings, or should the availability of short-term funding become restricted due to a disruption in the financial markets, the Company’s ability to obtain funding from these or other sources could be negatively impacted. The Company attempts to quantify such credit-event risk by modeling scenarios that estimate the liquidity impact resulting from a

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short-term ratings downgrade over various grading levels. The Company estimates such impact by attempting to measure the effect on available unsecured lines of credit, available capacity from secured borrowing sources and securitizable assets.

     The Company serves in the capacity of remarketing agent for variable rate demand bonds (“VRDBs”), in a line of business obtained in the Allfirst acquisition. The VRDBs are enhanced by a direct-pay letter of credit provided by M&T Bank. Holders of the VRDBs generally have the right to sell the bonds to the remarketing agent with seven days notice, which could result in M&T Bank owning the VRDBs for some period of time until such instruments are remarketed. When this occurs, the VRDBs are classified as trading assets in the Company’s consolidated balance sheet. The value of VRDBs in the Company’s trading account totaled $10 million at March 31, 2004 and $22 million at December 31, 2003. As of March 31, 2004 and December 31, 2003, the total amount of VRDBs outstanding backed by an M&T Bank letter of credit was $1.6 billion and $1.7 billion, respectively. M&T Bank also serves as remarketing agent for most of those bonds.

     The Company enters into contractual obligations in the normal course of business which require future cash payments. The Company also has off-balance sheet commitments to customers that may impact liquidity, including commitments to extend credit, standby letters of credit, commercial letters of credit, financial guarantees and indemnification contracts, and commitments to sell real estate loans. Since many of these commitments or contracts expire without being funded in whole or in part, the contract amounts are not necessarily indicative of future cash flows. Further discussion of these commitments is provided in note 7 of Notes to Financial Statements.

     M&T’s primary source of funds to pay for operating expenses, shareholder dividends and treasury stock repurchases has historically been the receipt of dividends from its banking subsidiaries, which are subject to various regulatory limitations. Dividends from any banking subsidiary to M&T are limited by the amount of earnings of the banking subsidiary in the current year and the two preceding years. For purposes of the test, at March 31, 2004 approximately $701 million was available for payment of dividends to M&T from banking subsidiaries without prior regulatory approval. These historic sources of cash flow have been augmented in the past by the issuance of trust preferred securities. Information regarding trust preferred securities and the related junior subordinated debentures is included in note 5 of Notes to Financial Statements. M&T also maintains a $30 million line of credit with an unaffiliated commercial bank, of which there were no borrowings outstanding at March 31, 2004 or at December 31, 2003.

     On an ongoing basis, management closely monitors the Company’s liquidity position for compliance with internal policies and believes that available sources of liquidity are adequate to meet funding needs anticipated in the normal course of business. Management does not currently anticipate engaging in any activities, either currently or in the long-term, for which adequate funding would not be available and would therefore result in a significant strain on liquidity at either M&T or its subsidiary banks.

     Market risk is the risk of loss from adverse changes in market prices and/or interest rates of the Company’s financial instruments. The primary market risk the Company is exposed to is interest rate risk. The core banking activities of lending and deposit-taking expose the Company to interest rate risk, which occurs when assets and liabilities reprice at different times and by different amounts as interest rates change. As a result, net interest income earned by the Company is subject to the effects of changing interest rates. The Company measures interest rate risk by calculating the variability of net interest income in future periods under various interest rate scenarios using projected balances for earning assets, interest-bearing liabilities and derivatives used to hedge interest rate risk. Management’s philosophy toward interest rate risk management is to limit the variability of net interest income. The balances of financial instruments used in the projections are based on expected growth from forecasted business opportunities, anticipated prepayments of loans and

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investment securities, and expected maturities of investment securities, loans and deposits. Management uses a “value of equity” model to supplement the modeling technique described above. Those supplemental analyses are based on discounted cash flows associated with on- and off-balance sheet financial instruments. Such analyses are modeled to reflect changes in interest rates and non-parallel shifts in the maturity curve of interest rates and provide management with a long-term interest rate risk metric.

     The Company’s Asset-Liability Committee, which includes members of senior management, monitors interest rate sensitivity with the aid of a computer model that considers the impact of ongoing lending and deposit-gathering activities, as well as interrelationships in the magnitude and timing of the repricing of financial instruments, including the effect of changing interest rates on expected prepayments and maturities. When deemed prudent, management has taken actions, and intends to do so in the future, to mitigate exposure to interest rate risk through the use of on- or off-balance sheet financial instruments. Possible actions include, but are not limited to, changes in the pricing of loan and deposit products, modifying the composition of earning assets and interest-bearing liabilities, and modifying or terminating existing interest rate swap agreements or other financial instruments used for interest rate risk management purposes.

     The accompanying table as of March 31, 2004 and December 31, 2003 displays the estimated impact on net interest income from non-trading financial instruments resulting from parallel changes in interest rates across repricing categories during the first modeling year.

SENSITIVITY OF NET INTEREST INCOME
TO CHANGES IN INTEREST RATES
(dollars in thousands)

     Many assumptions were utilized by the Company to calculate the impact that changes in interest rates may have on net interest income. The more significant assumptions related to the rate of prepayments of mortgage-related assets, cash flows from derivative and other financial instruments held for non-trading purposes, loan and deposit volumes and pricing, and deposit maturities. The Company also assumed gradual changes in rates during a twelve-month period, including incremental 100 and 200 basis point rate changes. In the event that a 100 or 200 basis point rate change cannot be achieved, the applicable rate changes are limited to lesser amounts such that interest rates cannot be less than zero. These assumptions are inherently uncertain and, as a result, the Company cannot precisely predict the impact of changes in interest rates on net interest income. Actual results may differ significantly from those presented due to the timing, magnitude and frequency of interest rate changes and changes in market conditions and interest rate differentials (spreads) between maturity/repricing categories, as well as any actions, such as those previously described, which management may take to counter such changes. In light of the uncertainties and assumptions associated with the process, the amounts presented in the table and changes in such amounts are not considered significant to the Company’s past or projected net interest income.

     The Company has historically engaged in trading activities to meet the financial needs of customers, to fund the Company’s obligations under certain deferred compensation plans and, to a limited extent, to profit from perceived market opportunities. Financial instruments utilized in trading activities have included forward and futures contracts related to foreign currencies and mortgage-backed securities, U.S. Treasury and other government securities, mortgage-backed securities, mutual funds and interest rate contracts, such as swap agreements. The Company generally mitigates the foreign currency and

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interest rate risk associated with trading activities by entering into offsetting trading positions. The amounts of gross and net trading positions as well as the type of trading activities conducted by the Company are subject to a well-defined series of potential loss exposure limits established by the Asset-Liability Committee. However, as with any non-government guaranteed financial instrument, the Company is exposed to credit risk associated with counterparties to the Company’s trading activities.

     The notional amounts of interest rate contracts entered into for trading purposes totaled $5.3 billion at March 31, 2004 and December 31, 2003, compared with $1.4 billion at March 31, 2003. The notional amounts of foreign currency and other option and futures contracts entered into for trading purposes were $605 million, $216 million and $548 million at March 31, 2004, March 31, 2003 and December 31, 2003, respectively. The notional amounts of these trading contracts are not recorded in the consolidated balance sheet. However, the fair values of all financial instruments used for trading activities are recorded in the consolidated balance sheet. The fair values of all trading account assets and liabilities were $213 million and $144 million, respectively, at March 31, 2004, $49 million and $34 million, respectively, at March 31, 2003, and $215 million and $139 million, respectively, at December 31, 2003. The higher amounts of trading account assets and liabilities at March 31, 2004 and December 31, 2003 reflect the fair values of interest rate swap agreements and foreign exchange contracts executed with customers associated with Allfirst and the related offsetting trading positions. Included in trading account assets at March 31, 2004, December 31, 2003 and March 31, 2003 were $43 million, $39 million and $13 million, respectively, related to deferred compensation plans. Changes in the fair value of such assets are recorded as trading account and foreign exchange gains in the consolidated statement of income. Included in other liabilities in the consolidated balance sheet at March 31, 2004, December 31, 2003 and March 31, 2003 were $51 million, $49 million and $22 million respectively, of liabilities related to deferred compensation plans. Changes in the balances of such liabilities due to the valuation of allocated investment options to which the liabilities are indexed are recorded in “other costs of operations” in the consolidated statement of income. Given the Company’s policies, limits and positions, management believes that the potential loss exposure to the Company resulting from market risk associated with trading activities was not material.

Provision for Credit Losses

The Company maintains an allowance for credit losses that in management’s judgment is adequate to absorb losses inherent in the loan and lease portfolio. A provision for credit losses is recorded to adjust the level of the allowance as deemed necessary by management. The provision for credit losses in the first quarter of 2004 was $20 million, down from $33 million in the year-earlier quarter and $28 million in 2003’s fourth quarter. Net loan charge-offs declined to $18 million in the recent quarter, compared with $25 million during the first quarter of 2003 and $32 million during the fourth quarter of 2003. Net charge-offs as an annualized percentage of average loans and leases were .20% in the recent quarter, significantly lower than .39% and .35% in the first and fourth quarters of 2003, respectively. Net charge-offs of loans acquired from Allfirst have not been significant. A summary of net charge-offs by loan type follows:

NET CHARGE-OFFS
BY LOAN/LEASE TYPE