Form 10-Q 2nd Quarter 2005


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

   
(Mark One)
 
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
       
   
For the quarterly period ended June 30, 2005 
 
       
   
Or
 
       
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
         
                    For the transition period from ____________________________ to __________________________

Commission File Number:0-15734

REPUBLIC BANCORP INC.
(Exact name of registrant as specified in its charter)

 
Michigan
 
38-2604669
 
 
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
         
 
1070 East Main Street, Owosso, Michigan
 
48867
 
 
(Address of principal executive offices)
 
(Zip Code)
 
         
 
(989) 725-7337
     
 
(Registrant's telephone number, including area code)
     
         
     
 
(Former name, former address and former fiscal year, if changed since last report)
 

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.
þYes oNo

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
þYes oNo

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 Outstanding as of July 31, 2005:
 
Common Stock, $5 Par Value Per Share
69,065,000 Shares





INDEX

PART I.
FINANCIAL INFORMATION
   
       
Item 1.
Financial Statements (Unaudited)
   
       
 
Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004
 
2
       
 
Consolidated Statements of Income for the Three and Six Months Ended June 30, 2005 and 2004
 
3
       
 
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2004
 
4
       
 
Notes to Consolidated Financial Statements
 
5 - 10
       
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
11 - 23
       
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
24 - 25
       
Item 4.
Controls and Procedures
 
26
       
PART II.
OTHER INFORMATION
   
       
Item 1.
Legal Proceedings
 
27
       
Item 2.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
 
27
       
Item 5.
Other Information
 
27
       
Item 6.
Exhibits
 
27
       
SIGNATURE
   
28
       


1



PART I - FINANCIAL INFORMATION
ITEM 1 - Financial Statements

REPUBLIC BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)
 
June 30,
2005
 
December 31, 2004
 
   
(Unaudited)
     
ASSETS
             
Cash and cash equivalents
 
$
55,575
 
$
53,671
 
Mortgage loans held for sale
   
143,589
   
105,318
 
Securities available for sale, at market
   
835,285
   
620,794
 
Securities held to maturity, at cost
   
252,527
   
222,757
 
Loans, net of unearned income
   
4,533,129
   
4,463,975
 
Less allowance for loan losses
   
(41,871
)
 
(41,818
)
Net loans
   
4,491,258
   
4,422,157
 
Federal Home Loan Bank stock (at cost)
   
80,514
   
80,511
 
Premises and equipment
   
25,687
   
26,493
 
Bank owned life insurance
   
114,414
   
112,978
 
Other assets
   
76,379
   
69,298
 
Total assets
 
$
6,075,228
 
$
5,713,977
 
               
LIABILITIES
             
Noninterest-bearing deposits
 
$
308,730
 
$
274,747
 
Interest-bearing deposits:
             
NOW accounts
   
196,221
   
203,553
 
Savings and money market accounts
   
1,000,565
   
1,103,675
 
Certificates of deposit under $100,000
   
704,009
   
662,357
 
Certificates of deposit $100,000 or greater
   
825,561
   
801,879
 
Total interest-bearing deposits
   
2,726,356
   
2,771,464
 
Total deposits
   
3,035,086
   
3,046,211
 
Federal funds purchased and other short-term borrowings
   
719,775
   
538,300
 
Short-term FHLB advances
   
362,500
   
215,000
 
Long-term FHLB advances and security repurchase agreements
   
1,434,934
   
1,390,878
 
Accrued expenses and other liabilities
   
63,826
   
63,950
 
Long-term debt
   
50,000
   
50,000
 
Total liabilities
   
5,666,121
   
5,304,339
 
               
SHAREHOLDERS’ EQUITY
             
Preferred stock, $25 stated value: $2.25 cumulative and convertible; 5,000,000 shares authorized, none  issued and outstanding
   
-
   
-
 
Common stock, $5 par value, 100,000,000 shares authorized; 69,205,000 and 70,425,000, issued and outstanding, respectively
   
346,026
   
352,125
 
Capital surplus
   
47,556
   
59,303
 
Unearned compensation - restricted stock
   
(6,323
)
 
(3,207
)
Retained earnings
   
23,024
   
3,634
 
Accumulated other comprehensive loss
   
(1,176
)
 
(2,217
)
Total shareholders’ equity
   
409,107
   
409,638
 
Total liabilities and shareholders’ equity
 
$
6,075,228
 
$
5,713,977
 

See notes to consolidated financial statements.


2



REPUBLIC BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
   
Three Months Ended
 
Six Months Ended
 
   
June 30,
 
June 30,
 
(In thousands, except per share data)
 
2005
 
2004
 
2005
 
2004
 
Interest Income:
                         
Interest and fees on loans
 
$
67,457
 
$
57,298
 
$
131,921
 
$
115,294
 
Interest on investment securities and FHLB stock dividends
   
13,280
   
10,694
   
24,657
   
20,517
 
Total interest income
   
80,737
   
67,992
   
156,578
   
135,811
 
                           
Interest Expense:
                         
Deposits
   
16,667
   
12,667
   
31,855
   
25,704
 
Short-term borrowings
   
8,325
   
2,319
   
13,945
   
4,337
 
Long-term FHLB advances and security repurchase agreements
   
15,919
   
15,734
   
31,549
   
31,544
 
Long-term debt
   
1,075
   
1,075
   
2,150
   
2,150
 
Total interest expense
   
41,986
   
31,795
   
79,499
   
63,735
 
Net interest income
   
38,751
   
36,197
   
77,079
   
72,076
 
Provision for loan losses
   
1,400
   
2,000
   
2,900
   
4,500
 
Net interest income after provision for loan losses
   
37,351
   
34,197
   
74,179
   
67,576
 
                           
Noninterest Income:
                         
Mortgage banking income
   
3,232
   
6,566
   
9,057
   
11,740
 
Service charges
   
3,008
   
3,005
   
5,689
   
5,702
 
Gain on sale of securities
   
292
   
674
   
727
   
1,362
 
Gain on sale of SBA loans
   
561
   
665
   
953
   
1,186
 
Income from bank owned life insurance
   
1,080
   
1,180
   
2,093
   
2,483
 
Other noninterest income
   
713
   
428
   
1,405
   
859
 
Total noninterest income
   
8,886
   
12,518
   
19,924
   
23,332
 
                           
Noninterest Expense:
                         
Salaries and employee benefits
   
12,350
   
13,835
   
25,766
   
25,924
 
Occupancy expense of premises
   
2,495
   
2,476
   
5,196
   
5,095
 
Equipment expense
   
1,599
   
1,652
   
3,223
   
3,326
 
Other noninterest expense
   
4,815
   
5,416
   
9,946
   
10,056
 
Total noninterest expense
   
21,259
   
23,379
   
44,131
   
44,401
 
Income before income taxes
   
24,978
   
23,336
   
49,972
   
46,507
 
Provision for income taxes
   
7,503
   
6,968
   
15,190
   
13,840
 
Net Income
 
$
17,475
 
$
16,368
 
$
34,782
 
$
32,667
 
                           
                           
Basic earnings per share
 
$
.25
 
$
.23
 
$
.50
 
$
.46
 
                           
Diluted earnings per share
 
$
.25
 
$
.23
 
$
.49
 
$
.46
 
                           
Average common shares outstanding - diluted
   
70,526
   
71,239
   
70,862
   
71,161
 
                           
Cash dividends declared per common share
 
$
.110
 
$
.086
 
$
.220
 
$
.173
 


See notes to consolidated financial statements.


3


REPUBLIC BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

Six Months Ended June 30 (In thousands)
 
2005
 
2004
 
Cash Flows From Operating Activities:
             
Net income
 
$
34,782
 
$
32,667
 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
 
 
 
 
Depreciation and amortization
 
 
5,837
 
 
5,398
 
Net gains on sale of securities available for sale
 
 
(727
)
 
(1,362
)
Net gains on sale of commercial and residential real estate loans
 
 
(3,492
)
 
(2,906
)
Proceeds from sale of mortgage loans held for sale
 
 
296,070
 
 
297,375
 
Origination of mortgage loans held for sale
 
 
(334,341
)
 
(216,851
)
Net increase in other assets
 
 
(14,625
)
 
(13,148
)
Net decrease in other liabilities
 
 
(124
)
 
(2,819
)
Other, net
 
 
56
 
 
2,815
 
Total adjustments
 
 
(51,346
)
 
68,502
 
Net cash (used in) provided by operating activities
   
(16,564
)
 
101,169
 
               
Cash Flows From Investing Activities:
             
Proceeds from sale of securities available for sale
   
130,985
   
58,280
 
Proceeds from calls and principal payments of securities available for sale
   
63,304
   
92,143
 
Proceeds from principal payments of securities held to maturity
   
21,067
   
25,790
 
Purchases of securities available for sale
   
(407,078
)
 
(313,898
)
Purchases of securities held to maturity
   
(50,921
)
 
(109,663
)
Proceeds from sale of commercial and residential real estate loans
   
196,726
   
111,055
 
Net increase in loans made to customers
   
(262,890
)
 
(306,976
)
Premises and equipment expenditures
   
(2,163
)
 
(3,557
)
Net cash used in investing activities
   
(310,970
)
 
(446,826
)
               
Cash Flows From Financing Activities:
             
Net (decrease) increase in total deposits
   
(11,125
)
 
8,912
 
Net increase in short-term borrowings
   
181,475
   
103,902
 
Net increase in short-term FHLB advances
   
147,500
   
111,000
 
Proceeds from long-term FHLB advances and security repurchase agreements
   
83,250
   
146,000
 
Payments on long-term FHLB advances
   
(38,703
)
 
(20,271
)
Net proceeds from issuance of common shares
   
6,790
   
6,129
 
Repurchase of common shares
   
(25,379
)
 
(889
)
Dividends paid on common shares
   
(14,370
)
 
(12,116
)
Net cash provided by financing activities
   
329,438
   
342,667
 
               
Net increase (decrease) in cash and cash equivalents
   
1,904
   
(2,990
)
Cash and cash equivalents at beginning of period
   
53,671
   
63,858
 
Cash and cash equivalents at end of period
 
$
55,575
 
$
60,868
 

See notes to consolidated financial statements.


4



REPUBLIC BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 1 - Basis of Presentation
The accompanying unaudited consolidated financial statements of Republic Bancorp Inc. and Subsidiaries (the “Company”) have been prepared in accordance with U. S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes necessary for a comprehensive presentation of financial position, results of operations and cash flow activity required by U. S. generally accepted accounting principles for complete financial statements. In the opinion of management, all normal recurring adjustments necessary for a fair presentation of results have been included. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

Note 2 - Principles of Consolidation
The consolidated financial statements include the accounts of the parent company, Republic Bancorp Inc. and its wholly owned bank subsidiary, Republic Bank (including its wholly-owned subsidiaries Quincy Investment Services, Inc., Republic Bank Real Estate Finance, LLC and Republic Management Company, Inc.). All significant intercompany accounts and transactions have been eliminated in consolidation.

Note 3 - Consolidated Statements of Cash Flows
Supplemental disclosures of cash flow information for the six months ended June 30, include:

(In thousands)
 
2005
 
2004
 
Cash paid during the period for:
             
Interest
 
$
77,970
 
$
61,879
 
Income taxes
 
$
14,762
 
$
13,300
 
               
Non-cash investing activities:
             
Loan charge-offs
 
$
3,596
 
$
3,754
 

Note 4 - Comprehensive Income
The following table sets forth the computation of comprehensive income:

   
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
(In thousands)
 
2005
 
2004
 
2005
 
2004
 
                           
Net income
 
$
17,475
 
$
16,368
 
$
34,782
 
$
32,667
 
                           
Unrealized holding gains (losses) on securities, net of tax (credit) of  $4,851, ($8,417), $815 and ($5,636), respectively
   
9,009
   
(15,631
)
 
1,514
   
(10,467
)
Reclassification adjustment for gains included in net income, net of tax of $102, $236, $254 and $477, respectively
   
(190
)
 
(438
)
 
(473
)
 
(885
)
Net unrealized gains (losses) on securities, net of tax
   
8,819
   
(16,069
)
 
1,041
   
(11,352
)
Comprehensive income
 
$
26,294
 
$
299
 
$
35,823
 
$
21,315
 

Note 5 - Intangible Assets
The following table summarizes the Company’s core deposit intangible asset which is subject to amortization:

(Dollars in thousands)
 
June 30,
2005
 
December 31, 2004
 
Core Deposit Intangible Asset:
             
Gross carrying amount
 
$
10,883
 
$
10,883
 
Accumulated amortization
   
7,391
   
6,894
 
Net book value
 
$
3,492
 
$
3,989
 

Amortization expense on the core deposit intangible asset totaled $244,000 and $247,500 for the quarters ended June 30, 2005 and 2004, and $497,000 and $495,000 for the six months ended June 30, 2005 and 2004, respectively. The Company expects core deposit intangible amortization expense to be $977,000, $864,000, $864,000, $704,000 and $156,000 for each of the years ending December 31, 2005, 2006, 2007, 2008 and 2009, respectively.

5



Note 6 - Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share:

   
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
(Dollars in thousands, except per share data)
 
2005
 
2004
 
2005
 
2004
 
Numerator for basic and diluted earnings per share:
                         
Net income
 
$
17,475
 
$
16,368
 
$
34,782
 
$
32,667
 
                           
Denominator for basic earnings per share - weighted-average shares
   
69,760,835
   
70,421,019
   
70,075,234
   
70,299,730
 
Effect of dilutive securities:
                         
Stock options
   
714,036
   
760,423
   
731,704
   
796,490
 
Warrants
   
50,849
   
57,532
   
54,791
   
65,119
 
Dilutive potential common shares
   
764,885
   
817,955
   
786,495
   
861,609
 
Denominator for diluted earnings per share—adjusted weighted-average shares for assumed conversions
   
70,525,720
   
71,238,974
   
70,861,729
   
71,161,339
 
                           
Basic earnings per share
 
$
.25
 
$
.23
 
$
.50
 
$
.46
 
Diluted earnings per share
 
$
.25
 
$
.23
 
$
.49
 
$
.46
 

Note 7 - Segment Information
The Company’s operations are managed as three major business segments: (1) commercial banking, (2) retail banking and (3) mortgage banking. The commercial banking segment consists of commercial lending to small- and medium-sized companies, primarily in the form of commercial real estate and Small Business Administration (SBA) loans. The retail banking segment consists of home equity lending, other consumer lending and the deposit-gathering function. Deposits and consumer loan products are offered through 82 retail branch offices of Republic Bank, which are staffed by personal bankers and loan originators. The mortgage banking segment is comprised of mortgage loan production. Mortgage loan production is conducted in all offices of Republic Bank. Treasury and Other is comprised of balance sheet management activities that include the securities portfolio, residential real estate mortgage portfolio loans and non-deposit funding. Treasury and Other also includes unallocated corporate expenses such as corporate overhead, including accounting, data processing, human resources, operation costs and any corporate debt.


6


Note 7 - Segment Information (Continued)

The following table presents the financial results of each business segment for the three months ended June 30, 2005 and 2004.

                       
(In thousands)
 
Commercial
 
Retail
 
Mortgage
 
Treasury
and Other
 
Consolidated
 
For the Three Months Ended June 30, 2005
                               
Net interest income from external customers
 
$
25,898
 
$
(6,642
)
$
3,047
 
$
16,448
 
$
38,751
 
Internal funding
   
(10,770
)
 
32,416
   
(1,225
)
 
(20,421
)
 
-
 
Net interest income
   
15,128
   
25,774
   
1,822
   
(3,973
)
 
38,751
 
Provision for loan losses
   
1,156
   
255
   
163
   
(174
)
 
1,400
 
Noninterest income
   
885
   
3,069
   
4,069
   
863
   
8,886
 
Noninterest expense
   
3,004
   
8,068
   
5,001
   
5,186
   
21,259
 
Income before taxes
   
11,853
   
20,520
   
727
   
(8,122
)
 
24,978
 
Income taxes
   
4,149
   
7,182
   
254
   
(4,082
)
 
7,503
 
Net income
 
$
7,704
 
$
13,338
 
$
473
 
$
(4,040
)
$
17,475
 
 
                               
Depreciation and amortization
 
$
25
 
$
725
 
$
441
 
$
1,403
 
$
2,594
 
Capital expenditures
 
$
2
 
$
210
 
$
44
 
$
1,262
 
$
1,518
 
Net identifiable assets (in millions)
 
$
1,624
 
$
2,914
 
$
266
 
$
1,271
 
$
6,075
 
Return on equity(1)
   
19.31
%
 
38.64
%
 
16.38
%
 
n/m
   
17.00
%
Return on assets
   
1.93
%
 
1.84
%
 
0.82
%
 
n/m
   
1.16
%
Efficiency ratio
   
18.76
%
 
27.97
%
 
84.89
%
 
n/m
   
44.01
%

(In thousands)
 
Commercial
 
Retail
 
Mortgage
 
Treasury
and Other
 
Consolidated
 
For the Three Months Ended June 30, 2004
                               
Net interest income from external customers
 
$
21,031
 
$
(6,197
)
$
3,856
 
$
17,507
 
$
36,197
 
Internal funding
   
(8,301
)
 
29,912
   
(1,709
)
 
(19,902
)
 
-
 
Net interest income
   
12,730
   
23,715
   
2,147
   
(2,395
)
 
36,197
 
Provision for loan losses
   
32
   
520
   
69
   
1,379
   
2,000
 
Noninterest income
   
860
   
3,069
   
7,755
   
834
   
12,518
 
Noninterest expense
   
2,489
   
7,784
   
5,717
   
7,389
   
23,379
 
Income before taxes
   
11,069
   
18,480
   
4,116
   
(10,329
)
 
23,336
 
Income taxes
   
3,949
   
6,593
   
1,441
   
(5,015
)
 
6,968
 
Net income
 
$
7,120
 
$
11,887
 
$
2,675
 
$
(5,314
)
$
16,368
 
                                 
Depreciation and amortization
 
$
30
 
$
734
 
$
432
 
$
1,271
 
$
2,467
 
Capital expenditures
 
$
4
 
$
119
 
$
73
 
$
177
 
$
373
 
Net identifiable assets (in millions)
 
$
1,535
 
$
2,775
 
$
243
 
$
1,159
 
$
5,711
 
Return on equity(1)
   
18.67
%
 
35.33
%
 
73.87
%
 
n/m
   
17.11
%
Return on assets
   
1.87
%
 
1.68
%
 
3.69
%
 
n/m
   
1.17
%
Efficiency ratio
   
18.31
%
 
29.06
%
 
57.74
%
 
n/m
   
47.64
%

(1)
Capital is allocated as a percentage of assets of 10% and 5% for the commercial and mortgage banking segments, respectively and is allocated as a percentage of deposits of 5% for the retail segment.
n/m
- not meaningful


7


Note 7 - Segment Information (Continued)

The following table presents the financial results of each business segment for the six months ended June 30, 2005 and 2004.

                       
(In thousands)
 
Commercial
 
Retail
 
Mortgage
 
Treasury
and Other
 
Consolidated
 
For the Six Months Ended June 30, 2005
                     
Net interest income from external customers
 
$
50,124
 
$
(12,842
)
$
6,268
 
$
33,529
 
$
77,079
 
Internal funding
   
(20,561
)
 
64,112
   
(3,092
)
 
(40,459
)
 
-
 
Net interest income
   
29,563
   
51,270
   
3,176
   
(6,930
)
 
77,079
 
Provision for loan losses
   
1,908
   
537
   
238
   
217
   
2,900
 
Noninterest income
   
1,590
   
5,856
   
9,124
   
3,354
   
19,924
 
Noninterest expense
   
5,944
   
16,069
   
9,922
   
12,196
   
44,131
 
Income before taxes
   
23,301
   
40,520
   
2,140
   
(15,989
)
 
49,972
 
Income taxes
   
8,155
   
14,182
   
749
   
(7,896
)
 
15,190
 
Net income
 
$
15,146
 
$
26,338
 
$
1,391
 
$
(8,093
)
$
34,782
 
                                 
Depreciation and amortization
 
$
54
 
$
1,467
 
$
865
 
$
3,451
 
$
5,837
 
Capital expenditures
 
$
16
 
$
584
 
$
63
 
$
1,500
 
$
2,163
 
Net identifiable assets (in millions)
 
$
1,624
 
$
2,914
 
$
266
 
$
1,271
 
$
6,075
 
Return on equity(1)
   
19.14
%
 
38.16
%
 
23.60
%
 
n/m
   
16.88
%
Return on assets
   
1.91
%
 
1.82
%
 
1.18
%
 
n/m
   
1.17
%
Efficiency ratio
   
19.08
%
 
28.13
%
 
80.67
%
 
n/m
   
45.00
%

(In thousands)
 
Commercial
 
Retail
 
Mortgage
 
Treasury
and Other
 
Consolidated
 
For the Six Months Ended June 30, 2004
                               
Net interest income from external customers
 
$
41,995
 
$
(12,970
)
$
7,780
 
$
35,271
 
$
72,076
 
Internal funding
   
(16,850
)
 
60,776
   
(3,406
)
 
(40,520
)
 
-
 
Net interest income
   
25,145
   
47,806
   
4,374
   
(5,249
)
 
72,076
 
Provision for loan losses
   
1,150
   
915
   
137
   
2,298
   
4,500
 
Noninterest income
   
1,617
   
5,874
   
12,903
   
2,938
   
23,332
 
Noninterest expense
   
4,490
   
15,388
   
11,049
   
13,474
   
44,401
 
Income before taxes
   
21,122
   
37,377
   
6,091
   
(18,083
)
 
46,507
 
Income taxes
   
7,536
   
13,335
   
2,132
   
(9,163
)
 
13,840
 
Net income
 
$
13,586
 
$
24,042
 
$
3,959
 
$
(8,920
)
$
32,667
 
                                 
Depreciation and amortization
 
$
60
 
$
1,468
 
$
882
 
$
2,988
 
$
5,398
 
Capital expenditures
 
$
24
 
$
2,482
 
$
281
 
$
770
 
$
3,557
 
Net identifiable assets (in millions)
 
$
1,535
 
$
2,775
 
$
243
 
$
1,159
 
$
5,711
 
Return on equity(1)
   
17.91
%
 
36.01
%
 
54.21
%
 
n/m
   
17.13
%
Return on assets
   
1.79
%
 
1.71
%
 
2.71
%
 
n/m
   
1.18
%
Efficiency ratio
   
16.78
%
 
28.67
%
 
63.95
%
 
n/m
   
46.22
%

(1)
Capital is allocated as a percentage of assets of 10% and 5% for the commercial and mortgage banking segments, respectively and is allocated as a percentage of deposits of 5% for the retail segment.
n/m
- not meaningful

8



Note 8 - Stock Based Compensation
Effective January 1, 2003, the Company adopted the fair value method of recording stock options under SFAS 123, Accounting for Stock-Based Compensation. In accordance with the transitional guidance of SFAS 148, Accounting for Stock-Based Compensation - Transition and Disclosure, the fair value method of accounting for stock options will be applied prospectively to awards granted subsequent to January 1, 2003. During 2003, 2004 and in the first six months of 2005, the Company generally awarded restricted stock in lieu of stock option grants. As a result, the GAAP income statement impact associated with expensing stock options in the first six months of 2005 and 2004 was immaterial. The income statement impact from expensing stock options is expected to be immaterial for the remainder of 2005. The Company continues to recognize compensation expense for restricted stock over the vesting period in accordance with APB Opinion 25. Such expense is included in salaries and employee benefits on the consolidated statements of income.

The following table presents net income and earnings per share had compensation cost for the Company’s stock-based compensation plans been determined in accordance with SFAS No. 123 for all outstanding and unvested awards for the three and six months ended June 30, 2005 and 2004.

   
Three Months Ended
 
Six Months Ended
 
   
June 30,
 
June 30,
 
(Dollars in thousands, except per share data)
 
2005
 
2004
 
2005
 
2004
 
                           
Net income (as reported)
 
$
17,475
 
$
16,368
 
$
34,782
 
$
32,667
 
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects
   
419
   
287
   
1,279
   
996
 
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects
   
(473
)
 
(402
)
 
(1,413
)
 
(1,251
)
Net income (pro forma)
 
$
17,421
 
$
16,253
 
$
34,648
 
$
32,412
 
                           
Basic earnings per share (as reported)
 
$
.25
 
$
.23
 
$
.50
 
$
.46
 
Basic earnings per share (pro forma)
   
.25
   
.23
   
.49
   
.46
 
                           
Diluted earnings per share (as reported)
 
$
.25
 
$
.23
 
$
.49
 
$
.46
 
Diluted earnings per share (pro forma)
   
.25
   
.23
   
.49
   
.46
 
                           

Note 9 - Off-Balance Sheet Instruments
In the normal course of business, the Company becomes a party to transactions involving financial instruments with off-balance sheet risk to meet the financing needs of its customers and to manage its own exposure to interest rate risk. These financial instruments include commitments to extend credit and standby letters of credit that are not reflected in the consolidated financial statements. The contractual amounts of these instruments express the extent of the Company’s involvement in these transactions as of the balance sheet date. These instruments involve, to varying degrees, elements of credit risk, market risk and liquidity risk in excess of the amount recognized in the consolidated balance sheets. However, management believes that they do not represent unusual risks for the Company.

Commitments to extend credit are legally binding agreements to lend cash to a customer as long as there is no breach of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Standby letters of credit guarantee the performance of a customer to a third party. The Company issues these guarantees primarily to support public and private borrowing arrangements, real estate construction projects, bond financing and similar transactions.

The credit risk associated with commitments to extend credit and standby letters of credit is essentially the same as that involved with direct lending. Therefore, these instruments are subject to the Company’s loan review and approval procedures and credit policies. Based upon management’s credit evaluation of the counterparty, the Company may require the counterparty to provide collateral as security for the agreement, including real estate, accounts receivable, inventories and investment securities. The maximum credit risk associated with these instruments equals their contractual amounts and assumes that the counterparty defaults and the collateral proves to be worthless. The total contractual amounts of commitments to extend credit and standby letters of credit do not necessarily represent future cash requirements, since many of these agreements may expire without being drawn upon. During 2004, the Company reclassified $2.8 million of its allowance for loan losses to a separate allowance for probable credit losses inherent in unfunded loan commitments. The separate allowance is included in “accrued expenses and other liabilities” and the balance was $2.7 million at June 30, 2005. Deferred revenue recorded for standby letters of credit was $144,000 and $367,000 at June 30, 2005 and December 31, 2004, respectively.

9


Note 9 - Off-Balance Sheet Instruments (Continued)
The following table presents the contractual amounts of the Company’s off-balance sheet financial instruments outstanding at June 30, 2005 and December 31, 2004.

           
(In thousands)
 
June 30,
2005
 
December 31,
2004
 
Financial instruments whose contract amounts represent credit risk:
             
Commitments to fund residential real estate loans
 
$
280,956
 
$
254,374
 
Commitments to fund commercial real estate loans
   
561,503
   
390,363
 
Other unused commitments to extend credit
   
451,109
   
422,652
 
Standby letters of credit
   
107,476
   
110,291
 

Note 10 - Legal Proceedings
The Company and its subsidiary are parties to litigation and claims arising in the normal course of their activities. Although the amount of ultimate liability, if any, with respect to such matters cannot be determined with reasonable certainty, management, after consultation with legal counsel, believes that the aggregate liability, if any, resulting from such matters would not have a material adverse effect on the Company’s consolidated financial condition.

Note 11 - Pending Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) revised SFAS 123, Accounting for Stock-Based Compensation. SFAS 123R establishes accounting requirements for share-based compensation to employees and carries forward prior guidance on accounting for awards to non-employees. This statement requires all stock-based compensation awards granted to employees be recognized in the financial statements at fair value. The provisions of this statement will become effective January 1, 2006 for all equity awards granted after the effective date. On January 1, 2003, the Company adopted the provisions of SFAS 123 and began recognizing compensation expense ratably in the income statement, based on the estimated fair value of all awards granted to employees after January 1, 2003. SFAS 123R requires an entity to recognize compensation expense based on an estimate of the number of awards expected to actually vest, exclusive of awards expected to be forfeited. Currently, the Company recognizes forfeitures as they occur. The adoption of this standard is not expected to have a material effect on the Company’s financial condition, results of operations or liquidity.

In March 2004, the FASB Emerging Issues Task Force (EITF) released Issue 03-1, Meaning of Other Than Temporary Impairment, which addressed other-than-temporary impairment for certain debt and equity investments. The recognition and measurement requirements of Issue 03-1, and other disclosure requirements not already implemented, were effective for periods beginning after June 15, 2004. In September 2004, FASB staff issued FASB Staff Position (FSP) EITF 03-1-a, which delayed the effective date for certain measurement and recognition guidance contained in Issue 03-1. The FSP required the application of pre-existing other-than-temporary guidance during the period of delay until a final consensus was reached. In June 2005, the FASB issued FSP EITF 03-1-a as final. The final FSP will supercede EITF 03-1. The final FSP (retitled FSP FAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments) will replace the guidance set forth in paragraphs 10-16 of Issue 03-1 with references to existing other-than-temporary guidance. FSP FAS 115-1 will also codify the guidance set forth in EITF Topic D-44, Recognition of Other-Than-Temporary-Impairment Upon the Planned Sale of a Security Whose Cost Exceeds Fair Value and clarify that an investor should recognize an impairment loss no later than when the impairment is deemed other than temporary, even if a decision to sell has not been made. FSP FAS 115-1 will become effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. The adoption of this standard is not expected to have a material effect on the Company’s financial condition, results of operations or liquidity.

On July 14, 2005, the FASB issued an Exposure Draft of a proposed Interpretation, Accounting for Uncertain Tax Positions - an Interpretation of FASB Statement No. 109. The FASB has proposed an asset recognition approach, applying a dual threshold, to account for uncertain tax positions. The proposed Interpretation would apply to all open tax positions accounted for in accordance with FAS 109, including those acquired in business combinations. Under the proposed Interpretation, the recognition of a tax benefit would occur when it is “probable” that the position would be sustained upon audit. The proposed Interpretation refers to the SFAS 5, Accounting for Contingencies, definition of probable (i.e., that which is likely to occur), which represents a level of assurance that is substantially higher than “more likely than not.” The proposed Interpretation would be effective as of the end of the first fiscal year ending after December 15, 2005. The adoption of this standard is not expected to have a material effect on the Company’s financial condition, results of operation or liquidity.


10


ITEM 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

EARNINGS PERFORMANCE

The Company reported net income for the quarter ended June 30, 2005 of $17.5 million. This compares to net income of $16.4 million for the second quarter of 2004. Diluted earnings per share for the second quarter of 2005 were $.25, up 8% from $.23 earned in the second quarter of 2004. Annualized returns on average assets and average shareholders’ equity for the quarter ended June 30, 2005 were 1.16% and 17.00%, respectively.

Net income for the six months ended June 30, 2005 was $34.8 million, compared to net income of $32.7 million earned for the same period in 2004. For the six month period ended June 30, 2005, diluted earnings per shares were $.49, an increase of 7% over the $.46 earned in 2004. Annualized returns on average assets and average shareholders’ equity for the first six months of 2005 were 1.17% and 16.88%, respectively.

RESULTS OF OPERATIONS

Net Interest Income
The following discussion should be read in conjunction with Tables 1 through 4 on pages 12-15, which identify and quantify the components impacting net interest income for the three and six months ended June 30, 2005 and 2004.

Net interest income, on a fully taxable equivalent (FTE) basis, was $39.7 million for the second quarter of 2005 compared to $37.2 million for the second quarter of 2004, an increase of 7%. The increase was primarily the result of an increase in the Company’s average interest earning assets of $408 million, or 8%, as the average balance of total securities increased $140 million, or 14%, and the average portfolio loan balance increased $317 million, or 8%, during the second quarter of 2005 compared to 2004. The increase in the average portfolio loan balance reflects a $70 million, or 5%, increase in average commercial loans, a $157 million, or 8%, increase in average residential real estate mortgage loans and a $90 million, or 14%, increase in average installment loans. Average total interest bearing liabilities increased $378 million for the second quarter of 2005 compared to 2004 due to a $148 million increase in total average interest-bearing deposits, a $222 million increase in average short-term borrowings and a $8 million increase in average long-term FHLB advances and security repurchase agreements.

The net interest margin (FTE) was 2.73% for the quarter ended June 30, 2005, a decrease of 2 basis points from 2.75% during the second quarter of 2004. The decrease in the margin was primarily attributable to the Company’s yield on earning assets increasing less than the increase in the cost of funds on interest-bearing liabilities.

For the six months ended June 30, 2005, net interest income (FTE) was $78.9 million, compared to $74.1 million for the first half of 2004. The increase was primarily the result of an increase in the Company’s average interest earning assets of $398 million, or 7%. The net interest margin (FTE) for the six months ended June 30, 2005, declined 3 basis points to 2.76% from 2.79% for the comparable period in 2004. The decrease in the margin was due to the Company’s yield on earning assets increasing less than the increase in the cost of funds on interest-bearing liabilities.


11


Net Interest Income (Continued)

Table 1 - Quarterly Net Interest Income (FTE)

   
Three Months Ended
June 30, 2005
 
Three Months Ended
June 30, 2004
 
(Dollars in thousands)
 
Average
Balance
 
Interest
 
Average
Rate
 
Average
Balance
 
Interest
 
Average
Rate
 
Average Assets:
                                     
Short-term investments
 
$
782
 
$
4
   
2.04
%
$
903
 
$
1
   
0.65
%
Mortgage loans held for sale
   
78,096
   
1,158
   
5.93
   
127,606
   
1,754
   
5.50
 
Securities available for sale: (1) 
                                     
Taxable
   
634,758
   
7,337
   
4.62
   
515,753
   
5,010
   
3.90
 
Tax-exempt
   
225,589
   
3,078
   
5.47
   
224,844
   
3,207
   
5.72
 
Securities held to maturity
   
257,529
   
2,970
   
4.61
   
236,784
   
2,654
   
4.48
 
Portfolio loans: (2)
                                     
Commercial loans
   
1,613,861
   
26,113
   
6.40
   
1,544,344
   
21,206
   
5.43
 
Residential real estate mortgage loans
   
2,172,126
   
28,459
   
5.24
   
2,014,715
   
25,684
   
5.10
 
Installment loans
   
747,193
   
11,727
   
6.30
   
656,756
   
8,654
   
5.28
 
Total loans, net of unearned income
   
4,533,180
   
66,299
   
5.83
   
4,215,815
   
55,544
   
5.25
 
Federal Home Loan Bank stock (at cost)
   
80,709
   
855
   
4.25
   
80,721
   
852
   
4.23
 
Total interest-earning assets
   
5,810,643
   
81,701
   
5.61
   
5,402,426
   
69,022
   
5.10
 
Allowance for loan losses
   
(41,986
)
             
(42,615
)
           
Cash and due from banks
   
46,963
               
56,025
             
Other assets
   
210,222
               
196,882
             
Total assets
 
$
6,025,842
             
$
5,612,718
             
                                       
Average Liabilities and Shareholders’ Equity:
                                     
Interest-bearing demand deposits
 
$
199,899
 
$
231
   
0.46
%
$
191,335
 
$
131
   
0.27
%
Savings and money market accounts
   
997,596
   
4,035
   
1.62
   
1,056,628
   
3,189
   
1.21
 
Certificates of deposit under $100,000
   
696,431
   
5,328
   
3.07
   
675,236
   
5,021
   
2.98
 
Certificates of deposit $100,000 or greater
   
836,569
   
7,073
   
3.39
   
658,912
   
4,326
   
2.63
 
Total interest-bearing deposits
   
2,730,495
   
16,667
   
2.45
   
2,582,111
   
12,667
   
1.97
 
Short-term borrowings
   
1,076,191
   
8,325
   
3.06
   
854,019
   
2,319
   
1.07
 
Long-term FHLB advances and security repurchase agreements
   
1,429,282
   
15,919
   
4.41
   
1,421,560
   
15,734
   
4.38
 
Long-term debt
   
50,000
   
1,075
   
8.60
   
50,000
   
1,075
   
8.60
 
Total interest-bearing liabilities
   
5,285,968
   
41,986
   
3.16
   
4,907,690
   
31,795
   
2.58
 
Noninterest-bearing deposits
   
286,356
               
283,691
             
Other liabilities
   
42,342
               
38,708
             
Total liabilities
   
5,614,666
               
5,230,089
             
Shareholders’ equity
   
411,176
               
382,629
             
Total liabilities and shareholders’ equity
 
$
6,025,842
             
$
5,612,718
             
                                       
Net interest income/rate spread (FTE)
       
$
39,715
   
2.45
%
     
$
37,227
   
2.52
%
                                       
FTE adjustment
       
$
964
             
$
1,030
       
                                       
Impact of noninterest
                                     
bearing sources of funds
               
.28
%
             
.23
%
                                       
Net interest margin (FTE)
               
2.73
%
             
2.75
%
                                       

(1)
To compare the tax-exempt asset yields to taxable yields, amounts are adjusted to pretax equivalents based on the marginal corporate Federal tax rate of 35%.
(2)
Non-accrual loans and overdrafts are included in average balances.



12


Net Interest Income (Continued)

Table 2 - Quarter Rate/Volume Analysis

               
Increase (decrease) due to change in:
 
Volume(1)
 
Rate(1)
 
Net Change
 
               
Interest Income:
                   
Short-term investments
 
$
-
 
$
3
 
$
3
 
Mortgage loans held for sale
   
(724
)
 
128
   
(596
)
Securities available for sale:
                   
Taxable
   
1,293
   
1,034
   
2,327
 
Tax-exempt
   
11
   
(140
)
 
(129
)
Securities held to maturity
   
237
   
79
   
316
 
Portfolio loans: (2)
                   
Commercial loans
   
988
   
3,919
   
4,907
 
Residential real estate mortgage loans
   
2,054
   
721
   
2,775
 
Installment loans
   
1,279
   
1,794
   
3,073
 
Total loans, net of unearned income
   
4,321
   
6,434
   
10,755
 
Federal Home Loan Bank stock (at cost)
   
-
   
3
   
3
 
Total interest income
   
5,138
   
7,541
   
12,679
 
                     
Interest Expense:
                   
Interest-bearing demand deposits
   
6
   
94
   
100
 
Savings deposits
   
(187
)
 
1,033
   
846
 
Certificates of deposit under $100,000
   
156
   
151
   
307
 
Certificates of deposit $100,000 or greater
   
1,326
   
1,421
   
2,747
 
Total interest-bearing deposits
   
1,301
   
2,699
   
4,000
 
Short-term borrowings
   
737
   
5,269
   
6,006
 
Long-term FHLB advances and security repurchase agreements
   
82
   
103
   
185
 
Long-term debt
   
-
   
-
   
-
 
Total interest expense
   
2,120
   
8,071
   
10,191
 
Net interest income (FTE)
 
$
3,018
 
$
(530
)
$
2,488
 

(1)
Variances attributable jointly to volume and rate changes are allocated to volume and rate in proportion to the relationship of the absolute dollar amount of the change in each.
(2)
Non-accrual loans and overdrafts are included in average balances.


13


Net Interest Income (Continued)

Table 3 - Six Months Ended Net Interest Income (FTE)

   
Six Months Ended
June 30, 2005
 
Six Months Ended
June 30, 2004
 
(Dollars in thousands)
 
Average
Balance
 
Interest
 
Average
Rate
 
Average
Balance
 
Interest
 
Average
Rate
 
Average Assets:
                                     
Short-term investments
 
$
1,421
 
$
13
   
1.77
%
$
671
 
$
2
   
0.68
%
Mortgage loans held for sale
   
95,767
   
2,820
   
5.89
   
110,225
   
3,128
   
5.68
 
Securities available for sale: (1) 
                                     
Taxable
   
582,619
   
13,318
   
4.55
   
488,668
   
9,513
   
3.90
 
Tax-exempt
   
212,788
   
5,779
   
5.48
   
217,422
   
6,286
   
5.80
 
Securities held to maturity
   
246,181
   
5,661
   
4.60
   
212,724
   
4,825
   
4.54
 
Portfolio loans: (2)
                                     
Commercial loans
   
1,600,064
   
50,583
   
6.29
   
1,535,407
   
42,323
   
5.45
 
Residential real estate mortgage loans
   
2,146,300
   
55,965
   
5.21
   
2,021,182
   
52,770
   
5.22
 
Installment loans
   
741,881
   
22,553
   
6.13
   
642,868
   
17,073
   
5.33
 
Total loans, net of unearned income
   
4,488,245
   
129,101
   
5.75
   
4,199,457
   
112,166
   
5.32
 
Federal Home Loan Bank stock (at cost)
   
80,710
   
1,681
   
4.20
   
80,727
   
1,909
   
4.74
 
Total interest-earning assets
   
5,707,731
   
158,373
   
5.55
   
5,309,894
   
137,829
   
5.18
 
Allowance for loan losses
   
(41,875
)
             
(41,769
)
           
Cash and due from banks
   
49,046
               
54,154
             
Other assets
   
208,535
               
192,962
             
Total assets
 
$
5,923,437
             
$
5,515,241
             
                                       
Average Liabilities and Shareholders’ Equity:
                                     
Interest-bearing demand deposits
 
$
200,189
 
$
452
   
0.46
%
$
187,539
 
$
255
   
0.27
%
Savings and money market accounts
   
1,040,631
   
8,244
   
1.60
   
1,048,983
   
6,656
   
1.27
 
Certificates of deposit under $100,000
   
685,026
   
10,206
   
3.00
   
677,421
   
10,170
   
3.01
 
Certificates of deposit $100,000 or greater
   
809,395
   
12,953
   
3.23
   
663,572
   
8,623
   
2.61
 
Total interest-bearing deposits
   
2,735,241
   
31,855
   
2.35
   
2,577,515
   
25,704
   
2.00
 
Short-term borrowings
   
985,279
   
13,945
   
2.81
   
790,838
   
4,337
   
1.08
 
Long-term FHLB advances and security repurchase agreements
   
1,420,863
   
31,549
   
4.42
   
1,408,890
   
31,544
   
4.43
 
Long-term debt
   
50,000
   
2,150
   
8.60
   
50,000
   
2,150
   
8.60
 
Total interest-bearing liabilities
   
5,191,383
   
79,499
   
3.06
   
4,827,243
   
63,735
   
2.63
 
Noninterest-bearing deposits
   
278,231
               
269,031