Fulton Financial
Annual Report 2005

Plain-text annual report

Organic Growth Fulton Financial Corporation Annual Report 2005 What makes the sapling flourish? Somewhere deep in its grain flows the instinct to reach with root and limb for what it needs to grow. Following that instinct – each in its own way – trees grow together to create a rich, thriving forest. Fulton Financial Corporation seeks out that natural inclination toward growth. We find it in the people who are a part of our organization. And in each of the independent community banks that have joined our family. Respect for organic wisdom – knowing how best to grow in one’s own environment – shapes our corporate philosophy. And our unique business model, grounded in a deep regard for the ability of the individual, has been the foundation for our history of strong, consistent growth. By valuing the wisdom of our people and of our local affiliate banks, we increase our collective wisdom, thus leading to collective success for our customers, our employees, and the communities we serve. The result is a thriving environment of growth ... which yields consistent returns for our shareholders. 2 | Fulton Financial Corporation Trees He Has Planted. Planting a tree is the ultimate act of optimism... of generosity...of vision for the future. Rufus A. Fulton, Jr., retired chairman and CEO, understands that kind of optimism and vision. But the trees planted on his farm over the years are just one sign of the man’s dedication to the future. Rufus has planted and cultivated much since joining Fulton National Bank in 1966. Beginning his Fulton career as the bank’s first management trainee, Rufus has held “It is often said that the mark of a leader toward career’s end is not so much what he did but what he left his people capable of doing. I believe that my mark, if I leave one, will be the leadership that is now in place to take Fulton Financial Corporation to greater heights for many years to come.” positions from trust administrator to trust officer, vice for a bank to be a good fit with the Corporation, it must be In describing Scott Smith, the company’s new chairman, president to senior vice president, president of Fulton located in an area that’s growing. It must have high asset CEO and president, Rufus says, “I have worked with Financial Corporation to CEO, and ultimately, chairman. quality. But most importantly, a bank must have employees Scott for more than 25 years. As a member of the FFC Along the way, he’s seen the organization grow from one bank in Pennsylvania to fifteen banks in five states; assets have grown from $86.4 million to $13.7 billion following our recent acquisition of Columbia Bancorp; and shareholders who have the same values as the employees at Fulton board of directors and as a shareholder, I have complete Financial. “You can teach people to do banking,” he says, confidence in Scott as he steps up to head our company.” “but it’s much harder to teach them how to treat co-workers and customers well if they don’t already know how.” As all who know him will attest, Rufus would rather talk about the exciting future of the company than dwell on his have increased from 2,400 to 51,000. When Rufus became Since his retirement, Rufus has left behind a legacy personal achievements – just the kind of perspective you’d president of the company in 1987, net income was $15.1 of lessons shared: about banking, and about caring for expect from one who plants trees. What’s rewarding isn’t million; during his tenure, it has increased more than tenfold. everyone involved – from customer and co-worker to the praise; but rather, the knowledge that the seeds he shareholder and community. He also leaves in place an planted will grow for a long, long time. His philosophy for successful growth relies on a balance between the internal and the external. According to Rufus, experienced, dedicated organization of people who have grown under his leadership. Fulton Financial Corporation | 3 Together, we grow. LETTER TO OUR SHAREHOLDERS Whether you’re a longtime shareholder or relatively is adjusted for the five-for-four stock split paid in We currently operate 254 branches located in new to the Fulton Financial Corporation family, June 2004. Long-term shareholders have realized Pennsylvania, New Jersey, Delaware, Maryland I hope you’ve been pleased by the consistent, an attractive return on their investment in Fulton and Virginia. reliable performance of our unique business model. Financial. For example, if you owned 100 shares Engineered for enduring growth and attractive of Fulton Financial Corporation common stock on returns, our way of doing business has yielded June 30, 1982, when the Corporation was formed, another year of solid achievement. your investment was $1,750. By doing nothing more Our performance this year is reflected in our financial highlights, as well as in some significant additional accomplishments: In 2005, our diluted net income per share increased 6.1% to $1.05 on total net income of $166.1 million. These results represent a return on average assets of 1.41% and a return on average tangible equity of 20.28%. The Corporation’s total capital was $1.3 billion at December 31, 2005, representing a book value per share of $8.17 and a tangible book value per share of $5.32. After two extraordinarily strong years of total shareholder returns in 2003 and 2004, Fulton Financial Corporation’s stock closed the year at $17.60 per share, compared to the 2004 close of $18.65, which than holding onto those shares, as of December 31, • Somerville, New Jersey-based SVB Financial 2005, you would have owned 2,056 shares, valued at Services, Inc., along with its sole banking subsidiary, approximately $36,000, for a compounded annual Somerset Valley Bank, joined Fulton Financial rate of return of 14% over the 24-year period. If you Corporation in July. This acquisition has reinforced had taken advantage of our dividend reinvestment our presence in central New Jersey with 12 plan, that same investment of $1,750 in 1982 community banking offices in Somerset, Hunterdon, would have had a 2005 year-end market value of and Middlesex counties ... while also helping us approximately $82,000, representing 4,641 shares, further enhance banking convenience for our for a compounded annual rate of return of 18%. existing New Jersey customers. With the 2004 We currently have roughly $13.7 billion in assets and a market capitalization of approximately $2.9 billion, which makes us the second largest commercial bank headquartered in the Third Federal Reserve District. addition of First Washington State Bank and this year’s acquisition of Somerset Valley, we now serve 14 of New Jersey’s 21 counties, providing more than 65 community banking locations in those markets. 4 | Fulton Financial Corporation • Columbia Bancorp, based in Columbia, Maryland, Rufus was the first graduate of our Management firsthand their dedication to our customers, our signed a definitive agreement in July to join Fulton Training Program, and has been an excellent example employees, our shareholders, and our communities. Financial Corporation. This acquisition, completed of how our Corporation attracts and retains people of Together, we look forward to building on the foundation on February 1, 2006, was Fulton Financial’s third talent and dedication. Our organization is fortunate to that Rufus has set, and I’m confident that we’re poised acquisition in Maryland, and our largest acquisition have formed our new senior management team with for strong, consistent growth as we meet the challenges to date. Columbia Bancorp’s sole banking subsidiary, several experienced long-term Fulton employees: and opportunities of the future ... as always, keeping The Columbia Bank establishes a Fulton Financial Charles J. Nugent, who continues to serve as senior our keen focus on satisfying customers, retaining presence in Howard, Montgomery, Prince George’s executive vice president and chief financial officer; valuable employees, and delivering consistent growth and Baltimore counties, as well as in Baltimore City Richard J. Ashby, Jr., senior executive vice president for our shareholders. with 20 full-service community banking offices and and head of the Corporation’s new Community five retirement community banking offices. Banking Group; James E. Shreiner, senior executive Another significant event was the retirement of our chairman and CEO, Rufus A. Fulton, Jr. We’ll miss him, his dedication, and his genuine care for the people of the corporation and the community. But he’s been generous with his legacy – the wisdom, vice president and senior administrative services officer; Craig H. Hill, senior executive vice president and head of human resources; and E. Philip Wenger, senior executive vice president and chairman and CEO of Fulton Bank, the Corporation’s largest banking affiliate. the values, and the high standards which have It’s exciting to have such collective experience on our energized and will continue to fuel the growth senior management team. I’ve worked with each of of our organization. these colleagues for many years, and I have experienced R. Scott Smith, Jr. Chairman, Chief Executive Officer, and President Fulton Financial Corporation | 5 Strong Roots. Solid Growth. Dan Schantz is a man of humble roots. When he and his wife, Mildred, purchased a small farm outside of Allentown, Pennsylvania, in 1957, he was looking simply to pursue his love of horticulture. But his 40 years of dedication, perseverance, and solid commitment to customer service grew his farm from a one-man operation into what has become a $25 million flower, specialty plant, and holiday bulb grower and distributor. Today, Dan Schantz Farm and Greenhouses supplies some of the largest retail stores in the country. Dan is a wise businessman who has always believed in the power of community. But as his profits continued Dan Schantz, customer of Lafayette Ambassador Bank, inspecting his poinsettia crop at the Dan Schantz Farm and Greenhouses near Allentown, Pennsylvania. to climb, fewer and fewer local banks could provide the And, backed by Fulton Financial Corporation, the largest As Lisa can testify, this unique model of banking has been level of support that his multi-million dollar corporation bank agricultural lender in the northeastern United States, integral to the success of Dan’s business. “We conduct a needed to thrive. As Lisa Myers, Dan’s company Lafayette Ambassador can supply Dan with significant lot of banking transactions each week. It’s nice to be able controller explains, “We were happy with our previous buying power and large cash management opportunities. to do everything locally, but still have constant access to local bank, but we needed a certain amount of As John Ditbrenner, Dan’s personal relationship manager fully integrated services – like investment management, financing, and they were just tapped out.” at Lafayette Ambassador Bank recalls, “Dan’s been doing cash management, and brokerage services.” So, in the process of a company change and looking to refinance, Dan joined Lafayette Ambassador Bank in 2000. As Lisa says, “We liked Lafayette Ambassador because of their customer service. But they were also business with us for about five years now. We make our lending decisions much more expediently than a larger bank could, but we also provide him a lot more financial assistance than most local banks could.” And it’s through that combination of services that Dan has managed to remain a community businessman – even as he’s evolved from local grower to national distributor, and from hometown farmer to “Pennsylvania Master Farmer.” able to make us the most comprehensive offer because In addition to a company retirement plan, cash management As John Ditbrenner will tell anyone, “We can meet all of of their affiliation with Fulton Financial Corporation. opportunities, and access to immediate credit, Fulton Dan’s business objectives through our relationship with They promised to take care of us, and they have.” affiliation has also broadened Dan’s banking power Fulton Financial. But we meet Dan’s most important As a long-time agricultural lender, the Corporation has an intimate understanding of the local farming community, so it’s easy to relate to Dan’s personal interests and goals. geographically. As Lisa explains,“We often conduct business needs simply through our close relationship with him and in Reading, Pennsylvania, which has no Lafayette Ambassador our understanding of his relationship to the community.” branches. But, because there’s another Fulton affiliate located there, we can still do our banking through them.” Fulton Financial Corporation | 7 An expanding circle of success. It starts with our people – people who arrive here assistant, and also completed the Management already motivated to grow and achieve. We invest in Training Program. “Each time I was ready for a new them through support, mentoring, and training ... as well challenge,” she says, “company growth presented as in the benefits and development opportunities they a new opportunity.” need to succeed in a well-rounded, well-balanced way. Fulton Bank president and chief operating officer Treated with value and respect, they pass those same Craig Roda also began as a Fulton Bank management qualities along to each other and to our customers. The trainee in 1979. “I knew from day one I’d found a home,” result is a community of highly skilled, close-knit and he says. “Whether it’s shareholders, customers, or highly loyal co-workers, an impressive employee retention employees, there’s a culture here of putting people first.” rate, and highly satisfied customers – customers who Once on the receiving end of mentoring within the enable us to continue investing in our people. Fulton organization, Craig is now able to continue People like Beth Bowers. She began her Fulton career in the company’s Management Training Program in 1979. She’s now senior vice president of Loan Documentation for Fulton Bank. “From the time I arrived, senior management the cycle, perpetuating the values which have fueled the company’s growth. “The people really do make the difference here,” he says. “I’ve seen and experienced just how true that is.” Four graduates of the Management Training Program (from left to right): Phil Wenger, Beth Bowers, Carolyn Pennabecker and Craig Roda. Beth, Carolyn, Craig, Phil and many other graduates set a good example,” she says. “They demonstrated a “It’s a great place to work,” says Phil Wenger. That could of the Management Training Program have grown into genuine desire to recognize the worth of employees.” explain his longevity at Fulton; Phil arrived in 1979, seasoned officer-level employees; these one-time Beth says it is this corporate culture, combined with the when he too joined the Management Training Program. trainees and others like them now provide leadership bank’s commitment to the surrounding community, that Of the program, Phil says it’s what helps to create and to their company as well as to the co-workers following has proven to be a winning combination – for employees, retain such a highly-skilled, multi-dimensional team of in their footsteps. customers, and shareholders. employees. “It’s a great way for newcomers to discover Carolyn Pennabecker is executive vice president of the Wealth Management Division of Fulton Financial Advisors. But she didn't start there; she originally joined Fulton Bank as a personal trust administrative what they can do here, to experience a lot of different aspects of the business, and to see what Fulton Financial is all about.” Phil would know – he’s now chairman and CEO of Fulton Bank and senior executive vice president for Fulton Financial Corporation. “It’s a dynamic, growing organization,” Phil says, “and that growth yields many career opportunities for many folks.” And thus, our circle of success continues to grow. Fulton Financial Corporation | 9 Sowing Success. Since its founding in 1990, Skylands Community Bank has been known for relationship-style banking. With a solid mission, strong team, and a strong reputation for small business banking, the bank offered customers some of the best service in its community. But joining Fulton Financial Corporation in 2000 enabled Skylands to offer some of the best service in the state of New Jersey. Fulton Financial affiliation gave Skylands the means to offer a higher lending capacity and new services like investment management and cash management. As it added these new amenities to its unique personality, the bank flourished. Yet, Skylands’ strong growth in market share, loans, deposits, and customer satisfaction hasn’t altered management team. Mike Halpin, president and CEO of Skylands Bank, holding a picture of his its accessible image or quality local reputation. In its seamless union with Fulton Financial, Skylands And it was important to Mike to hold on to that team. role in our success,” according to Mike. “That culture enjoys the continued loyalty of its existing customers Because he, like every good leader, sees his hardworking of respect is apparent to our customers, too. And that while attracting scores of new ones. “Unlike many employees as his biggest asset. “At Skylands Community makes everyone happy.” mergers, ours was very effective – with no disruption,” Bank, we make it a point to value everyone’s contributions says Mike Halpin, president and CEO of Skylands equally. All of our employees feel genuinely respected Community Bank. and needed,” states Mike. Skylands Community Bank is an example of how Fulton Financial’s affiliate banks can maintain autonomy while tapping into the holding company’s resources and In gaining access to Fulton Financial’s considerable As they have leveraged their founding philosophies with enjoying inspiring growth. Mike Halpin agrees. “This is assets and services, Skylands retained its local the financial strength of Fulton Financial Corporation, a great affiliation. We are living proof that the Fulton management and decision-making authority. “One the Skylands team has blossomed. They can now Financial way of doing business is mutually beneficial – of the best things about joining Fulton Financial was add greater customer borrowing power and broader for the holding company and its shareholders, and for that just about everyone was able to keep their investment opportunities to their repertoire of services. the affiliate bank and its customers.” jobs – which is a rarity,” says Mike. “Everyone agrees that Fulton Financial plays a critical Fulton Financial Corporation | 11 Fulton Financial Corporation Senior Management Fulton Financial Corporation Fulton Bank Divisional Boards R. Scott Smith, Jr. Chairman, Chief Executive Officer and President Charles J. Nugent Senior Executive Vice President/ Chief Financial Officer Richard J. Ashby, Jr. Senior Executive Vice President/ Community Banking Group James E. Shreiner Senior Executive Vice President/ Senior Administrative Services Officer Craig H. Hill Senior Executive Vice President/ Human Resources E. Philip Wenger Senior Executive Vice President/ Chairman and CEO of Fulton Bank Seated: R. Scott Smith, Jr. Standing, from left: James E. Shreiner, E. Philip Wenger, Charles J. Nugent, Craig H. Hill, Richard J. Ashby, Jr. 12 | Fulton Financial Corporation Board of Directors Capital Division East Petersburg Jeffrey G. Albertson, Esq. Robert S. Jones, Chairman John M. Bond, Jr. James C. Byerly Donald C. Emich, Chairman William R. Gamber II Donald M. Bowman, Jr. Samuel T. Cooper III, Esq. Kenneth L. Kreider Craig A. Dally, Esq. Clark S. Frame Patrick J. Freer Rufus A. Fulton, Jr. Eugene H. Gardner George W. Hodges Carolyn R. Holleran Clyde W. Horst Thomas W. Hunt Willem Kooyker Donald W. Lesher, Jr. Joseph J. Mowad, M.D. Abraham S. Opatut Mary Ann Russell John O. Shirk, Esq. R. Scott Smith, Jr. Gary A. Stewart Fulton Bank Board of Directors Larry D. Bashore Dana A. Chryst Eugene H. Gardner James M. Herr George A. Parmer Harlowe R. Prindle A. Richard Pugh Craig A. Roda John O. Shirk, Esq. E. Philip Wenger James S. Wisotzkey Steven S. Etter Dolores Liptak Barry E. Musser, C.P. A. Drovers Division David W. Freeman, Chairman Vernon L. Bracey Sally J. Dixon Robert S. Freed Roger L. Holland Gary A. Stewart, Jr. Delaine A. Toerper Constance L. Wolf Great Valley Division Gerald A. Nau, Chairman Michael Fromm Kathryn G. Goodman Daniel M. Goodyear Carolyn R. Holleran Jessica H. May Elizabethtown Sherri L. Gorman, Chairman Nancy Z. Garber David B. Mueller David W. Sweigart III Gap Aldus R. King, Chairman A. Charles Artinian Ruth D. Doutrich Hershey/Hummelstown Charles J. DeHart III, Esq., Chairman Jack B. Billmyer Thomas S. Davis, M.D. Joan E. Spire Daniel A. Verdelli Leola William G. Koch, Sr., C.P. A. Joanne B. Ladley, Chairman Robert M. Bard Richard M. Hurst Lititz Ronald L. Miller, C.P. A., Chairman Irel D. Buckwalter Wilbur G. Rohrer Paul W. Stauffer Fulton Bank Advisory Boards Akron/Lincoln/Ephrata Larry L. Loose, Chairman Fred N. Buch Richard A. Hess Louis G. Hurst Kent M. Martin Denver Michael L. Weinhold, C.P.A., Chairman Larry L. Gensemer Gerald L. Harding Ralph W. Roseboro Affiliate Bank Board of Directors Manheim Peter J. Hondru, Chairman H. Reid Graybill Peter B. McCracken Lebanon Valley Farmers Bank Randall I. Ebersole Patrick J. Freer Robert J. Funk Robert W. Obetz, Jr. Robert P. Hoffman Joanne E. Wade Larry D. Sauder Wendie DiMatteo Holsinger J. David Young, Jr., Esq. Donald W. Lesher, Jr. Robert J. Longo Andrew M. Marhevsky Albert B. Murry M. Randolph Tice Joseph J. Mowad, M.D. Lawrence M. DiVietro, Jr. Thomas E. Mackell, M.D. FNB Bank, N.A. Robert O. Booth Richard A. Grafmyre James D. Hawkins Hagerstown Trust Donald M. Bowman, Jr. James C. Bryan Jack B. Castle Paul N. Crampton, Jr. Raymond A. Grahe Joseph F. Adams, C.P. A. Daniel E. Cohen Jeffrey G. Albertson, Esq. Clark S. Frame Dennis N. DeSimone John J. Ginley Sandra J. Gubbine Scott H. Kintzing Warner A. Knobe Ross Levitsky, Esq. Sarah (Sally) Love Robert R. McHarness Angela M. Snyder Barry J. Miles, Sr. Daniel A. Nesi, M.D. Neil W. Norton Thomas M. O’Mara Brian R. Rich Ezio U. Rossi Richard F. Ryon Daniel G. Timms, D.D.S. Gerald Schatz The Bank Premier Bank Somerset Valley Bank Swineford National Bank Donald R. Harsh, Jr. Thomas C. Clark, Esq. Richard F. Erdley Ann E. Kaye Michael N. O’Keefe Edwin A. Rhoads Michael R. Wimer Gene D. Zartman Lafayette Ambassador Bank Gary A. Clewell Craig A. Dally, Esq. L. Anderson Daub Doris E. Lehman Bernard P. Lesky Paul C. Mellott, Jr. Delaware National Bank Dale R. Dukes Jeffrey M. Fried Amy A. Higgins Mark E. Huntley Greg N. Johnson Terry A. Megee Ronald T. Moore Ralph W. Simpers Paul J. Tully The Peoples Bank of Elkton Harry C. Brown Judy E. Hart Donald S. Hicks Mark E. Huntley Robert O. Palsgrove Nancy R. Simpers David K. Williams, Jr. Skylands Community Bank Sara (Sally) Jane Gammon David T. Wilgus Norman S. Baron Thomas J. Maloney, Esq. Gordon E. Wood Sr., Esq. Daniel M. DiCarlo, Jr. John C. Soffronoff Irving N. Stein HelenBeth Garofalo Vilcek John A. Zebrowski Resource Bank Alfred E. Abiouness T.A. Grell, Jr. Thomas W. Hunt Louis R. Jones A. Russell Kirk Lawrence N. Smith Elizabeth Addington Twohy Harry L. Lundy, Jr. Alan B. McFall, Esq. Jamie P. Musselman Edith Ritter Robert A. Rupel John J. Simon Robert C. Wood First Washington State Bank James N. Corcodilos Michael Halpin Raymond Nisivoccia, C.P. A. Harry Horowitz Denis H. O’Rourke Paul J. Pinizzotto Leslie E. Smith, Jr. Mark F. Strauss, Esq. Norman Worth James R. Johnson, Jr. Jerry Kokes Joe J. Mayes, Jr. Abraham S. Opatut Steven I. Pfeffer C. Herbert Schneider New Holland R. Douglas Good, Esq., Chairman Vernon R. Martin John D. Yoder Oxford Wilmer L. Hostetter James D. McLeod, Jr. Quarryville Dwight E. Wagner, Chairman Frank M. Abel, V.M.D. John E. Chase James W. Hostetter, Sr., C.P.A. Agricultural Advisory Board Harry H. Bachman Amos J. Balsbaugh I. Hershey Bare Henry M. Berger Richard E. Brandt P. Larry Groff, Sr. Dennis L. Grumbine William Hostetter Amos M. Hursh Aldus R. King Jay H. Kopp Peter B. McCracken Bernard Bernstein Robert P. Corcoran John K. Kitchen Willem Kooyker Frank Orlando Gilbert E. Pittenger Frederick D. Quick Anthony J. Santye, Jr. Donald Sciaretta Herman Simonse Donald Tourville, Ph.D. The Columbia Bank Anand S. Bhasin John M. Bond, Jr. Robert R. Bowie, Jr., Esq. Garnett Y. Clark, Jr. Hugh F. Cole, Jr. William L. Hermann Charles C. Holman Winfield M. Kelly, Jr. Herschel L. Langenthal Raymond G. Laplaca, Esq. Morris A. Little Kenneth H. Michael James R. Moxley, III James R. Moxley, Jr. Vincent D. Palumbo, M.D. John A. Scaldara, Jr. Mary S. Scrivener Lawrence A. Shulman, Esq. Maurice M. Simpkins Robert N. Smelkinson Theodore G. Venetoulis James J. Winn, Jr., Esq. Fulton Financial Corporation | 13 FINANCIAL HIGHLIGHTS PER-SHARE DATA Net income (diluted) Cash dividends Shareholders’ equity 2005 $1.05 0.567 8.17 2004 $0.99 0.518 7.92 2003 $0.96 0.475 6.67 AT YEAR END (Dollars in thousands) Total assets $12,402,000 $11,160,000 $9,769,000 Loans, net of unearned 8,425,000 Deposits Shareholders’ equity 8,805,000 1,283,000 7,534,000 7,896,000 1,244,000 6,140,000 6,752,000 948,000 P E R C E N T C H A N G E 2005/2004 2004/2003 6% 9% 3% 11% 12% 12% 3% 3% 9% 19% 14% 23% 17% 31% Shares outstanding 157,017,000 Number of shareholders Number of employees 51,000 4,379 NET INCOME PER SHARE (diluted) $ 0.96 $ 0.99 $ 1.05 03 04 05 DIVIDENDS PER SHARE $ 0.475 $ 0.518 $ 0.567 03 04 05 RETURN ON AVERAGE EQUITY* 20.28 % 18.58 % 17.33 % 03 04 05 1.5 0.75 0 0.6 0.3 0 20.0 15.0 10.0 *Net income, as adjusted for intangible amortization (net of tax) divided by average shareholders’ equity, net of goodwill and intangible assets. 14 | Fulton Financial Corporation Investor Information Stock Listing Form 10-K Common shares of Fulton Financial Corporation are traded A copy of the Corporation’s Annual Report to the under the symbol “FULT” and are listed in the National Securities and Exchange Commission, Form 10-K, Bank Subsidiaries Fulton Bank Lebanon Valley Farmers Bank Swineford National Bank Market System of NASDAQ. Dividend Calendar Dividends on Fulton Financial Corporation’s common stock are customarily payable on or about the 15th of January, April, July and October. Dividend Reinvestment Plan and Direct Deposit of Cash Dividends Fulton Financial Corporation offers its shareholders the convenience of a Dividend Reinvestment and Stock Purchase Plan, and direct deposit of cash dividends. Holders of stock may have their quarterly dividends automatically reinvested in additional shares of the Corporation’s common stock by utilizing the Dividend Reinvestment Plan. Shareholders participating in the Plan may also make voluntary cash contributions not to exceed $5,000 per month. In addition, shareholders also have the option of having their cash dividends sent directly to their financial institution for deposit into their checking or savings account. Shareholders may receive information on either the Dividend Reinvestment Plan and Stock Purchase Plan or direct deposit of cash dividends by writing to: Stock Transfer Department Fulton Financial Advisors, N.A. P.O. Box 3215 Lancaster, PA 17604-3215 or calling: (717) 291-2546 or 1-800-626-0255. can be viewed on the Corporation’s website at www.fult.com. In addition, copies may be obtained Lafayette Ambassador Bank without charge to shareholders by writing to: Corporate Secretary Fulton Financial Corporation P.O. Box 4887 Lancaster, PA 17604-4887 The Annual Meeting and Luncheon of Shareholders of Fulton Financial Corporation will be held on Tuesday, May 2, 2006, at noon in the Great American Hall of the Hershey Lodge and Convention Center, West Chocolate Avenue and University Drive, FNB Bank, N.A. Hagerstown Trust Delaware National Bank The Bank The Peoples Bank of Elkton Skylands Community Bank Premier Bank Resource Bank Hershey, PA. Please note that any shareholder who First Washington State Bank would like to attend MUST HAVE A RESERVATION. You may let us know that you will attend by returning the Reservation Form included in your proxy mailing. Somerset Valley Bank The Columbia Bank Your reservation will help ensure that we have adequate seating for all shareholders who plan to join us that day. Residential lending offered through Fulton Mortgage Company and Resource Mortgage Financial Services Affiliates Fulton Financial Advisors, N.A. Deardon, Maguire, Weaver, and Barrett, LLC Fulton Insurance Services Group, Inc. Fulton Financial Corporation One Penn Square P.O. Box 4887 Lancaster, PA 17604 1.800.FULTON.4 www.fult.com  Fulton Financial Corporation Description Page 5-Year Consolidated Summary of Financial Results......................................................................... Management’s Discussion and Analysis of Results of Operations and Financial Condition............ 2 3 Consolidated Balance Sheets ............................................................................................................. 35 Consolidated Statements of Income................................................................................................... 36 Consolidated Statements of Shareholders’ Equity and Comprehensive Income............................... 37 Consolidated Statements of Cash Flows............................................................................................ 38 Notes to Consolidated Financial Statements ..................................................................................... 39 Management Report on Internal Control Over Financial Reporting ................................................. 70 Reports of Independent Registered Public Accounting Firm ............................................................ 71 Quarterly Consolidated Results of Operations (Unaudited) .............................................................. 74 Fulton Financial Corporation 5-YEAR CONSOLIDATED SUMMARY OF FINANCIAL RESULTS (dollars in thousands, except per-share data) 2005 2004 SUMMARY OF INCOME Interest income ............................................ $ 625,797 Interest expense ........................................... 213,219 Net interest income...................................... 412,578 Provision for loan losses.............................. 3,120 Other income ............................................... 144,268 Other expenses............................................. 316,291 Income before income taxes........................ 237,435 Income taxes ................................................ 71,361 Net income................................................... $ 166,074 PER-SHARE DATA (1) Net income (basic)....................................... $ Net income (diluted).................................... Cash dividends............................................. 1.06 1.05 0.567 For the Year 2003 $ 435,531 131,094 304,437 9,705 134,370 233,651 195,451 59,084 $ 136,367 2002 2001 $ 469,288 158,219 311,069 11,900 114,012 226,046 187,135 56,181 $ 130,954 $ 518,680 227,962 290,718 14,585 102,057 220,292 157,898 46,136 $ 111,762 $ 493,643 135,994 357,649 4,717 138,864 277,515 214,281 64,673 $ 149,608 $ $ 1.00 0.99 0.518 $ 0.97 0.96 0.475 $ 0.93 0.92 0.425 0.79 0.78 0.385 RATIOS Return on average assets ............................. Return on average equity............................. Return on average tangible equity (2) ......... Net interest margin ...................................... Efficiency ratio ............................................ Average equity to average assets................. Dividend payout ratio .................................. 1.41% 1.45% 1.55% 13.24 20.28 3.93 55.50 10.70 54.00 13.98 18.58 3.83 55.90 10.30 52.30 15.23 17.33 3.82 54.00 10.20 49.50 1.66% 15.61 17.25 4.35 52.70 10.60 46.20 1.49% 14.33 15.97 4.27 55.50 10.40 49.40 PERIOD-END BALANCES Total assets .................................................. $12,401,555 Loans, net of unearned income.................... 8,424,728 Deposits ....................................................... 8,804,839 Federal Home Loan Bank advances and long-term debt............................. Shareholders' equity..................................... 860,345 1,282,971 AVERAGE BALANCES Total assets .................................................. $11,779,096 Loans, net of unearned income.................... 7,981,604 Deposits ....................................................... 8,364,435 Federal Home Loan Bank advances and long-term debt............................. Shareholders' equity..................................... 837,305 1,254,476 $11,160,148 7,533,915 7,895,524 $ 9,768,669 6,140,200 6,751,783 $ 8,388,915 5,295,459 6,245,528 $ 7,771,598 5,373,020 5,986,804 684,236 1,244,087 568,730 948,317 535,555 864,879 456,802 812,341 $10,344,768 6,857,386 7,285,134 $ 8,803,285 5,564,806 6,505,371 $ 7,901,398 5,381,950 6,052,667 $ 7,520,763 5,341,497 5,771,089 637,654 1,069,904 566,437 895,616 476,415 839,111 500,162 779,706 (1) Adjusted for stock dividends and stock splits. (2) Net income, as adjusted for intangible amortization (net of tax), divided by average shareholders’ equity, net of goodwill and intangible assets. 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation Management’s Discussion and Analysis of Financial Condition and Results of Operations (Management’s Discussion) concerns Fulton Financial Corporation (the Corporation), a financial holding company registered under the Bank Holding Company Act and incorporated under the laws of the Commonwealth of Pennsylvania in 1982, and its wholly owned subsidiaries. This discussion and analysis should be read in conjunction with the consolidated financial statements and other financial information presented in this report. FORWARD-LOOKING STATEMENTS AND RISK FACTORS The Corporation has made, and may continue to make, certain forward-looking statements with respect to acquisition and growth strategies, market risk, the effect of competition on net interest margin and net interest income, investment strategy and income growth, investment securities gains, other-than-temporary impairment of investment securities, deposit and loan growth, asset quality, balances of risk-sensitive assets to risk-sensitive liabilities, employee benefits and other expenses, amortization of intangible assets, goodwill impairment, capital and liquidity strategies and other financial and business matters for future periods. The Corporation cautions that these forward-looking statements are subject to various assumptions, risks and uncertainties. Because of the possibility that the underlying assumptions may change, actual results could differ materially from these forward-looking statements. In addition to the factors identified herein, the following risk factors could cause actual results to differ materially from such forward- looking statements: (cid:120)(cid:3) Changes in interest rates may have an adverse effect on the Corporation’s profitability. (cid:120)(cid:3) Changes in economic conditions and the composition of the Corporation’s loan portfolios could lead to higher loan charge-offs or an increase in Fulton’s allowance for loan losses and may reduce the Corporation’s income. (cid:120)(cid:3) Fluctuations in the value of the Corporation’s equity portfolio, or assets under management by the Corporation’s trust and investment management services, could have a material impact on the Corporation’s results of operations. (cid:120)(cid:3) (cid:120)(cid:3) If the Corporation is unable to acquire additional banks on favorable terms or if it fails to successfully integrate or improve the operations of acquired banks, the Corporation may be unable to execute its growth strategies. If the goodwill that the Corporation has recorded in connection with its acquisitions becomes impaired, it could have a negative impact on the Corporation’s profitability. (cid:120)(cid:3) The competition the Corporation faces is increasing and may reduce the Corporation’s customer base and negatively impact the Corporation’s results of operations. (cid:120)(cid:3) The supervision and regulation by various regulatory authorities to which the Corporation is subject can be a competitive disadvantage. The Corporation’s forward-looking statements are relevant only as of the date on which such statements are made. By making any forward-looking statements, the Corporation assumes no duty to update them to reflect new, changing or unanticipated events or circumstances. OVERVIEW As a financial institution with a focus on traditional banking activities, the Corporation generates the majority of its revenue through net interest income, the difference between interest income earned on loans and investments and interest paid on deposits and borrowings. Growth in net interest income is dependent upon balance sheet growth and maintaining or increasing the net interest margin, which is net interest income (fully taxable-equivalent) as a percentage of average interest-earning assets. The Corporation also generates revenue through fees earned on the various services and products offered to its customers and through sales of assets, such as loans or investments. Offsetting these revenue sources are provisions for credit losses on loans, operating expenses and income taxes. 3 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The Corporation’s net income for 2005 increased $16.5 million, or 11.0%, from $149.6 million in 2004 to $166.1 million in 2005. Diluted net income per share increased $0.06, or 6.1%, from $0.99 per share in 2004 to $1.05 per share in 2005. In 2005, the Corporation realized a return on average assets of 1.41% and a return on average tangible equity of 20.28%, compared to 1.45% and 18.58%, respectively, in 2004. Net income for 2004 increased $13.2 million, or 9.7%, from $136.4 million in 2003. Diluted net income per share increased $0.03, or 3.1%, from $0.96 per share in 2003. In 2005, the Corporation adopted Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (Statement 123R), using modified retrospective application. Statement 123R requires that the fair value of equity awards to employees be recognized as compensation expense over the period during which an employee is required to provide service in exchange for such award and, under the modified retrospective application, prior period results are restated. As a result, all financial information in this report has been restated to reflect the impact of adoption. For the year ended December 31, 2004, net income and diluted net income per share were reduced by $3.3 million and $0.02, respectively. For the year ended December 31, 2003, net income and diluted net income per share were reduced by $1.8 million and $0.02, respectively. See Note M, “Stock-Based Compensation Plans and Shareholders’ Equity”, in the Notes to Consolidated Financial Statements for information on the impact of adopting Statement 123R and its effect on prior periods. The 2005 increase in earnings was driven by a $54.9 million, or 15.4%, increase in net interest income due to both internal and external growth and a year-over-year increase in net interest margin. Also contributing to the increase in earnings was a $16.5 million, or 13.6%, increase in other income (excluding securities gains), primarily as a result of acquisitions. These items were offset by a $38.8 million, or 14.0%, increase in other expenses, also primarily due to recent acquisitions, and an $11.1 million, or 62.6%, reduction in investment securities gains. The following summarizes some of the more significant factors that influenced the Corporation’s 2005 results. Interest Rates – Changes in the interest rate environment generally impact both the Corporation’s net interest income and its non- interest income. The interest rate environment reflects both the level of short-term rates and the slope of the U. S. Treasury yield curve, which plots the yields on treasury issues over various maturity periods. During the past year, the yield curve has flattened, with short-term rates increasing at a faster pace than longer-term rates. Floating rate loans, short-term borrowings and savings and time deposit rates are generally influenced by short-term rates. During 2005, the Federal Reserve Board (FRB) raised the Federal funds rate eight times, for a total increase of 200 basis points since December 31, 2004, with the overnight borrowing, or Federal funds, rate ending the year at 4.25%. The Corporation’s prime lending rate had a corresponding increase, from 5.25% to 7.25%. The increase in short-term rates benefited the Corporation during the first half of 2005 as floating rate loans quickly adjusted to higher rates, while increases in deposit rates – which are more discretionary – were less pronounced. Throughout the remainder of the year, competitive pressures resulted in increases in deposit rates. While the net interest margin for the year increased over the prior year, during 2005 it was flat, which is shown in the following table: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Year to Date 2005 3.95% 3.92 3.92 3.92 3.93 2004 3.79% 3.73 3.88 3.92 3.83 With respect to longer-term rates, the 10-year treasury yield, which is a common benchmark for evaluating residential mortgage rates, increased to 4.39% at December 31, 2005 as compared to 4.24% at December 31, 2004. Mortgage rates have been historically low over the past several years, generating strong refinance activity and significant gains for the Corporation as fixed-rate residential mortgages are generally sold in the secondary market. With only a minimal increase in long-term rates from the prior year, origination volumes and the resulting gains on sales of these loans remained strong, continuing to contribute to the Corporation’s non-interest income. If rates continue to rise and the yield curve steepens, residential mortgage volume could decrease, resulting in a negative impact on non-interest income, as gains on sale would decline. The “Market Risk” section of Management’s Discussion summarizes the expected impact of rate changes on net interest income. 4 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation Earning Assets - The Corporation’s interest-earning assets increased from 2004 to 2005 as a result of acquisitions, as well as internal loan growth. This growth also contributed to the increase in net interest income. From 2004 to 2005, the Corporation experienced a shift in its composition of interest-earning assets from investments (23.2% of total average interest-earning assets in 2005, compared to 26.8% in 2004) to loans (74.1% in 2005, compared to 71.7% in 2004). This change resulted from strong loan demand being partially funded with the proceeds from maturing investment securities. The movement to higher-yielding loans has had a positive effect on the Corporation’s net interest income and net interest margin. Asset Quality – Asset quality refers to the underlying credit characteristics of borrowers and the likelihood that defaults on contractual loan payments will result in charge-offs of account balances. Asset quality is generally a function of economic conditions, but can be managed through conservative underwriting and sound collection policies and procedures. The Corporation has been able to maintain strong asset quality through different economic cycles, attributable to its credit culture and underwriting policies. This trend continued in 2005 as net charge-offs to average loans decreased from 0.06% in 2004 to 0.04% in 2005. Non-performing assets to total assets increased to 0.38% at December 31, 2005, from 0.30% at December 31, 2004, however, this level is still relatively low in absolute terms. While overall asset quality has remained strong, deterioration in quality of one or several significant accounts could have a detrimental impact and result in losses that may not be foreseeable based on current information. In addition, rising interest rates could increase the total payments of borrowers and could have a negative impact on their ability to pay according to the terms of their loans. Equity Markets – As disclosed in the “Market Risk” section of Management’s Discussion, equity valuations can have an impact on the Corporation’s financial performance. In particular, bank stocks account for a significant portion of the Corporation’s equity investment portfolio. Historically, gains on sales of these equities have been a recurring component of the Corporation’s earnings, although realized gains have decreased in recent quarters. Declines in bank stock portfolio values could have a detrimental impact on the Corporation’s ability to recognize gains in the future. Acquisitions – In July 2005, the Corporation acquired SVB Financial Services, Inc. (SVB) of Somerville, New Jersey, a $530 million bank holding company whose primary subsidiary was Somerset Valley Bank. In December 2004, the Corporation acquired First Washington FinancialCorp (First Washington), of Windsor, New Jersey, a $490 million bank holding company whose primary subsidiary was First Washington State Bank. In April 2004, the Corporation acquired Resource Bankshares Corporation (Resource); an $890 million financial holding company located in Virginia Beach, Virginia whose primary subsidiary was Resource Bank. Period- to-period comparisons in the “Results of Operations” section of Management’s Discussion are impacted by these acquisitions when 2005 results are compared to 2004. Results for 2004 in comparison to 2003 were impacted by the acquisitions of First Washington, Resource and Premier Bancorp, Inc., which was acquired in August 2003. The discussion and tables within the “Results of Operations” section of Management’s Discussion highlight the contributions of these acquisitions in addition to internal changes. On February 1, 2006, the Corporation completed its acquisition of Columbia Bancorp (Columbia), of Columbia, Maryland. Columbia was a $1.3 billion bank holding company whose primary subsidiary was The Columbia Bank, which operates 19 full-service community-banking offices and five retirement community offices in Howard, Montgomery, Prince George’s and Baltimore Counties and Baltimore City. For additional information on the terms of these acquisitions, see Note Q, “Mergers and Acquisitions”, in the Notes to Consolidated Financial Statements. Acquisitions have long been a supplement to the Corporation’s internal growth, providing the opportunity for the Corporation’s existing products and services to be sold in new markets. The Corporation’s acquisition strategy focuses on high growth areas with strong market demographics and targets organizations that have a comparable corporate culture, strong performance and good asset quality, among other factors. Under its “supercommunity” banking philosophy, acquired organizations generally retain their status as separate legal entities, unless consolidation with an existing affiliate bank is practical. Back office functions are generally consolidated to maximize efficiencies. 5 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Merger and acquisition activity in the financial services industry has been very competitive in recent years, as evidenced by the prices paid for certain acquisitions. While the Corporation has been an active acquirer, management is committed to basing its pricing on rational economic models. Management will continue to focus on generating growth in the most cost-effective manner. 6 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation RESULTS OF OPERATIONS Net Interest Income Net interest income is the most significant component of the Corporation’s net income, accounting for approximately 75% of total 2005 revenues, excluding investment securities gains. The ability to manage net interest income over a variety of interest rate and economic environments is important to the success of a financial institution. Growth in net interest income is generally dependent upon balance sheet growth and maintaining or growing the net interest margin. The “Market Risk” section of Management’s Discussion provides additional information on the policies and procedures used by the Corporation to manage net interest income. The following table provides a comparative average balance sheet and net interest income analysis for 2005 compared to 2004 and 2003. Interest income and yields are presented on a fully taxable-equivalent (FTE) basis, using a 35% Federal tax rate. The discussion following this table is based on these tax-equivalent amounts. Year Ended December 31 Yield/ Rate (1) Average Balance 2005 Interest $ 520,595 75,150 17,971 5,333 98,454 14,940 1,586 635,575 Yield/ Rate (1) Average Balance 6.52% 3.76 4.87 4.02 3.94 6.17 3.27 5.90 $ 6,857,386 2,161,195 264,578 133,870 2,559,643 135,758 6,067 9,558,854 2004 Interest $ 398,190 76,792 14,353 4,974 96,119 8,407 103 502,819 5.82% 3.55 5.43 3.72 3.74 6.19 1.70 5.26 (dollars in thousands) Average Balance ASSETS Interest-earning assets: Loans and leases (2) ................... $ 7,981,604 Taxable inv. securities (3) .......... 1,994,740 Tax-exempt inv. securities (3) .... 368,845 Equity securities (3).................... 132,564 Total investment securities ........... 2,496,149 Loans held for sale...................... 241,996 Other interest-earning assets....... 48,357 Total interest-earning assets ......... 10,768,106 Non-interest-earning assets: Cash and due from banks ........... Premises and equipment ............. Other assets (3) ........................... Less: Allowance for loan losses.............................. (92,780) Total Assets......................... $ 11,779,096 346,535 158,526 598,709 LIABILITIES AND SHAREHOLDERS’ EQUITY Interest-bearing liabilities: Demand deposits ........................ $ 1,547,766 Savings deposits ......................... 2,055,503 Time deposits ............................. 3,171,901 Total interest-bearing deposits...... 6,775,170 Short-term borrowings................ 1,186,464 Long-term debt ........................... 837,305 Total interest-bearing liabilities.... 8,798,939 Non-interest-bearing liabilities: Demand deposits ........................ 1,589,265 Other........................................... 136,416 Total Liabilities .................. 10,524,620 Shareholders' equity...................... 1,254,476 Total Liabs. and Equity ...... $ 11,779,096 $ 15,370 27,116 98,288 140,774 34,414 38,031 213,219 0.99% 1.32 3.10 2.08 2.87 4.54 2.42 316,170 128,902 425,825 (84,983) $ 10,344,768 $ 1,364,953 1,846,503 2,693,414 5,904,870 1,238,073 637,654 7,780,597 1,380,264 114,003 9,274,864 1,069,904 $ 10,344,768 $ 7,201 11,928 70,650 89,779 15,182 31,033 135,994 0.53% 0.65 2.62 1.52 1.23 4.87 1.75 2003 Interest $ 343,883 77,450 15,650 5,051 98,151 2,953 241 445,228 Yield/ Rate (1) 6.18% 3.57 5.87 3.90 3.80 5.99 1.06 5.43 $ 6,011 10,770 77,417 94,198 7,373 29,523 131,094 0.52% 0.65 3.10 1.77 1.00 5.21 1.98 $ 5,564,806 2,170,889 266,426 129,584 2,566,889 49,271 22,708 8,203,684 279,980 123,172 271,758 (75,309) $ 8,803,285 $ 1,158,333 1,655,325 2,496,234 5,309,892 738,527 566,437 6,614,856 1,195,479 97,334 7,907,669 895,616 $ 8,803,285 Net interest income/net interest margin (FTE).......................... Tax equivalent adjustment............ Net interest income....................... 3.93% 422,356 (9,778) $ 412,578 3.83% 366,825 (9,176) $ 357,649 3.82% 314,134 (9,697) $ 304,437 (1) Presented on a fully tax equivalent (FTE) basis using a 35% Federal tax rate. (2) (3) Balances include amortized historical cost for available for sale securities. The related unrealized holding gains (losses) are included in other assets. Includes non-performing loans. 7 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following table sets forth a summary of changes in FTE interest income and expense resulting from changes in average balances (volumes) and changes in rates: 2005 vs. 2004 Increase (decrease) due To change in Rate Volume 2004 vs. 2003 Increase (decrease) due To change in Rate Net Net Volume (in thousands) Interest income on: Loans and leases .................................... Taxable investment securities ................ Tax-exempt investment securities .......... Equity securities ..................................... Loans held for sale.................................. Short-term investments .......................... $ 70,346 (5,995) 5,224 (49) 6,559 1,310 $ 52,059 4,353 (1,606) 408 (26) 173 $ 122,405 (1,642) 3,618 359 6,533 1,483 $ 77,526 (345) (111) 164 5,353 (235) $ (23,219) (313) (1,186) (241) 101 97 Total interest-earning assets ............ $ 77,395 $ 55,361 $ 132,756 $ 82,352 $ (24,761) Interest expense on: Demand deposits .................................... Savings deposits .................................... Time deposits ......................................... Short-term borrowings ........................... Long-term debt ...................................... $ 1,076 1,488 13,677 (648) 9,346 $ 7,093 13,700 13,961 19,880 (2,348) $ 8,169 15,188 27,638 19,232 6,998 $ 1,088 1,236 5,796 5,839 3,551 $ 102 (78) (12,563) 1,970 (2,041) $ $ $ 54,307 (658) (1,297) (77) 5,454 (138) 57,591 1,190 1,158 (6,767) 7,809 1,510 Total interest-bearing liabilities ....... $ 24,939 $ 52,286 $ 77,225 $ 17,510 $ (12,610) $ 4,900 Note: Changes which are partly attributable to rate and volume are allocated based on the proportion of the direct changes attributable to rate and volume. 2005 vs. 2004 Net interest income (FTE) increased $55.5 million, or 15.1%, from $366.8 million in 2004 to $422.4 million in 2005, due to both average balance growth and a higher net interest margin for 2005 in comparison to 2004. Average interest-earning assets grew 12.7%, from $9.6 billion in 2004 to $10.8 billion in 2005. Acquisitions contributed approximately $1.1 million to this increase in average balances. Interest income (FTE) increased $132.8 million, or 26.4%, partially as a result of the increase in average earning assets, which contributed $77.4 million of the increase, with the remaining growth in interest income (FTE) due to an increase in rates on interest-earning assets. 8 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation The increase in average interest-earning assets was due to loan growth, both internal and through acquisitions, as investment balances remained relatively flat. Average loans increased by $1.1 billion, or 16.4%, to $8.0 billion in 2005. The following table presents the growth in average loans, by type: 2005 Increase (decrease) % $ 2004 (dollars in thousands) Commercial - industrial and financial........................... $ 2,022,615 Commercial - agricultural ............................................. 324,637 Real estate - commercial mortgage ............................... 2,621,730 Real estate - residential mortgage and home equity...... 1,713,442 Real estate - construction .............................................. 732,847 Consumer ...................................................................... 499,220 Leasing and other.......................................................... 67,113 Total.................................................................. $ 7,981,604 $ 1,769,801 330,269 2,205,025 1,498,047 487,954 495,544 70,746 $ 6,857,386 $ 252,814 (5,632) 416,705 215,395 244,893 3,676 (3,633) $ 1,124,218 14.3% (1.7) 18.9 14.4 50.2 0.7 (5.1) 16.4% Acquisitions contributed approximately $694.5 million to the increase in average balances. The following table presents the average balance impact of acquisitions, by type: 2005 2004 (in thousands) Increase Commercial - industrial and financial........................... $ 214,840 Commercial - agricultural ............................................. 1,297 Real estate - commercial mortgage ............................... 381,411 Real estate - residential mortgage and home equity...... 163,959 Real estate - construction .............................................. 418,283 Consumer ...................................................................... 7,027 Leasing and other.......................................................... 8,480 Total.................................................................. $ 1,195,297 $ $ 84,080 520 133,705 63,411 213,340 1,725 4,001 500,782 $ 130,760 777 247,706 100,548 204,943 5,302 4,479 $ 694,515 The following table presents the growth in average loans, by type, excluding the average balances contributed by acquisitions: 2005 Increase (decrease) % 2004 $ (dollars in thousands) Commercial - industrial and financial........................... $ 1,807,775 Commercial - agricultural ............................................. 323,340 Real estate - commercial mortgage ............................... 2,240,319 Real estate - residential mortgage and home equity...... 1,549,483 Real estate - construction .............................................. 314,564 Consumer ...................................................................... 492,193 Leasing and other.......................................................... 58,633 Total.................................................................. $ 6,786,307 $ 1,685,721 329,749 2,071,320 1,434,636 274,614 493,819 66,745 $ 6,356,604 $ $ 122,054 (6,409) 168,999 114,847 39,950 (1,626) (8,112) 429,703 7.2% (1.9) 8.2 8.0 14.5 (0.3) (12.2) 6.8% Excluding the impact of acquisitions, loan growth continued to be strong in the commercial and commercial mortgage categories, which together increased $284.6 million, or 7.0%, over 2004. Construction loans grew $40.0 million, or 14.5%, in comparison to 9 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION 2004 due mainly to increased activity in the Pennsylvania and New Jersey markets. Residential mortgage and home equity loans showed strong growth due to promotional efforts and customers using home equity loans as a cost-effective refinance alternative. The average yield on loans during 2005 of 6.52% represents a 70 basis point, or 12.0%, increase in comparison to 2004. This increase reflects the impact of a significant portfolio of floating rate loans, which repriced as interest rates increased throughout the year. Average investments decreased $63.5 million, or 2.5%, in comparison to 2004. Excluding the impact of acquisitions, the investment balances would have decreased $390.7 million, or 15.8%. During 2004, proceeds from investment maturities were used to fund loan growth, however during 2005 the Corporation’s purchases of new investment securities exceeded proceeds from sales and maturities. The average yield on investment securities improved 20 basis points from 3.74% in 2004 to 3.94% in 2005. This improvement was due partially to premium amortization decreasing, which is accounted for as a reduction of interest income, from $10.5 million in 2004 to $6.9 million in 2005 as prepayments on mortgage-backed securities decreased. The remaining increase was due to the maturity of lower yielding investments, with reinvestment at higher rates. The following table presents the growth in average deposits, by type: 2005 2004 $ (dollars in thousands) Increase % Non-interest-bearing demand.... $ 1,589,265 Interest-bearing demand............ 1,547,766 Savings/money market.............. 2,055,503 Time deposits ............................ 3,171,901 Total ............................... $ 8,364,435 $ 1,380,264 1,364,953 1,846,503 2,693,414 $ 7,285,134 $ 209,001 182,813 209,000 478,487 $ 1,079,301 15.1% 13.4 11.3 17.8 14.8% Acquisitions accounted for approximately $956.0 million of the increase in average balances. The following table presents the average balance impact of acquisitions, by type: 2005 2004 (in thousands) Increase Non-interest-bearing demand.... $ Interest-bearing demand............ Savings/money market.............. Time deposits ............................ 153,483 147,493 285,104 795,538 Total ............................... $ 1,381,618 $ $ 29,985 46,077 34,282 315,256 425,600 $ $ 123,498 101,416 250,822 480,282 956,018 The following table presents the growth in average deposits, by type, excluding the contribution of acquisitions: 2005 Increase (decrease) % 2004 $ (dollars in thousands) Non-interest-bearing demand.... $ 1,435,782 Interest-bearing demand............ 1,400,273 Savings/money market.............. 1,770,399 Time deposits ............................ 2,376,363 Total ............................... $ 6,982,817 $ 1,350,279 1,318,876 1,812,221 2,378,158 $ 6,859,534 $ $ 85,503 81,397 (41,822) (1,795) 123,283 6.3% 6.2 (2.3) (0.1) 1.8% 10 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation Interest expense increased $77.2 million, or 56.8%, to $213.2 million in 2005 from $136.0 million in 2004. The increase in interest expense was primarily due to a 67 basis point, or 38.3%, increase in the cost of total interest-bearing liabilities in 2005 in comparison to 2004. Competitive pricing pressures have resulted in increased deposit rates in response to the FRB’s rate increases throughout 2005. The remaining increase in interest expense was due to a $1.0 billion, or 13.1%, increase in total interest-bearing liabilities, partially due to acquisitions, and partially due to internal growth. Average borrowings increased slightly during 2005, with the $51.6 million decrease in average short-term borrowings more than offset by a $199.7 million increase in long-term debt. Excluding the impact of acquisitions, average short-term borrowings decreased $147.4 million, or 13.4%, mainly due to a decrease in Federal funds purchased. In addition, customer cash management accounts, which are included in short-term borrowings, decreased $20.6 million, or 5.1%, to an average of $385.7 million in 2005. Average long-term debt increased $199.7 million, or 31.3%, to $837.3 million, with acquisitions contributing $51.7 million to the long-term debt increase. The additional increase in long-term borrowings was due to the Corporation’s issuance of $100.0 million ten-year subordinated notes in March 2005 and an increase in Federal Home Loan Bank advances as longer-term rates were locked in anticipation of continued rate increases. 2004 vs. 2003 Net interest income (FTE) increased $52.7 million, or 16.8%, from $314.1 million in 2003 to $366.8 million in 2004, primarily as a result of earning asset growth, as the Corporation’s net interest margin of 3.83% was only one basis point higher than the 2003 net interest margin of 3.82%. Average earning assets grew 16.5%, from $8.2 billion in 2003 to $9.6 billion in 2004. Acquisitions contributed approximately $900.0 million to this increase in average balances. Interest income increased $57.6 million, or 12.9%, mainly as a result of the 16.5% increase in average earning assets, which resulted in an $82.4 million increase in interest income. This increase was partially offset by the $24.8 million decrease in interest income that resulted from the decline in average yields earned. Average loans increased by $1.3 billion, or 23.2%, to $6.9 billion in 2004. Acquisitions contributed approximately $675.6 million to this increase in average balances. Loan growth was strong in the commercial and commercial mortgage categories. The growth experienced in the commercial – agricultural category resulted from an agricultural loan portfolio purchased in December 2003. The reduction in mortgage loan balances was due to customer refinance activity that occurred during 2003. The Corporation generally sells newly originated fixed rate mortgages in the secondary market to promote liquidity and manage interest rate risk. Home equity loans increased significantly due to promotional efforts and customers using home equity loans as a cost-effective refinance alternative. Consumer loans decreased, reflecting customers’ repayment of these loans with tax-advantaged residential mortgage or home equity loans. In addition, the indirect finance market remained extremely competitive with the participation of vehicle manufacturers. The average yield on loans during 2004 was 5.82%, a 36 basis point, or 5.8%, decline from 2003. Much of the loan growth during the year was in the floating rate categories that tend to carry lower interest rates than fixed-rate products. Average investments decreased slightly during 2004, however, without the impact of acquisitions, the investment balances would have decreased $165.9 million, or 6.6%. The Corporation’s investment balances had increased over the last few years due to both significant deposit growth and the use of limited strategies to manage the Corporation’s gap position and to take advantage of low short-term borrowing rates. During 2004, the Corporation did not reinvest a significant portion of investment maturities in order to minimize interest rate risk in expectation of a rising rate environment and to help fund loan growth. The average yield on investment securities declined slightly from 3.80% in 2003 to 3.74% in 2004. Premium amortization, which is accounted for as a reduction of interest income, was $20.0 million in 2003 compared to $10.5 million in 2004. The benefit from the lower premium amortization was offset by the reduction in stated yields experienced throughout 2004. Interest expense increased $4.9 million, or 3.7%, to $136.0 million in 2004 from $131.1 million in 2003, mainly as a result of a $1.2 billion increase in average interest-bearing liabilities, which included approximately $800 million added by acquisitions. The increase in average interest-bearing liabilities resulted in an increase in interest expense of $17.5 million during 2004. This increase was 11 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION partially offset by a $12.6 million decrease due to the 23 basis point decrease in the cost of total interest-bearing liabilities. The cost of interest-bearing deposits declined 25 basis points, or 14.1%, from 1.77% in 2003 to 1.52% in 2004. This reduction was due to both the impact of declining short-term interest rates in the first half of 2003 and the continuing shifts in the composition of deposits from higher-rate time deposits to lower-rate demand and savings deposits. Customers continued to exhibit an unwillingness to invest in certificates of deposit at the rates available, instead keeping their funds in demand and savings products. Acquisitions accounted for approximately $595.4 million of the increase in average deposit balances. Average borrowings increased significantly during 2004, with average short-term borrowings increasing $499.5 million, or 67.6%, to $1.2 billion, and average long-term debt increasing $71.2 million, or 12.6%, to $637.7 million. Acquisitions added $174.6 million to the short-term borrowings increase and $83.6 million to the long-term debt increase. The additional increase in short-term borrowings resulted primarily from certain limited strategies employed during 2003 to manage the Corporation’s gap position and to take advantage of low short-term borrowing rates. In addition, customer cash management accounts, which are included in short-term borrowings, grew $54.9 million, or 15.6%, to an average of $406.2 million in 2004. Provision and Allowance for Loan Losses The Corporation accounts for the credit risk associated with lending activities through its allowance and provision for loan losses. The provision is the expense recognized in the income statement to adjust the allowance to its proper balance, as determined through the application of the Corporation’s allowance methodology procedures. These procedures include the evaluation of the risk characteristics of the portfolio and documentation in accordance with the Securities and Exchange Commission’s (SEC) Staff Accounting Bulletin No. 102, “Selected Loan Loss Allowance Methodology and Documentation Issues” (SAB 102). See the “Critical Accounting Policies” section of Management’s Discussion for a discussion of the Corporation’s allowance for loan loss evaluation methodology. 12 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation A summary of the Corporation's loan loss experience follows: 2005 2004 Year Ended December 31 2003 (dollars in thousands) 2002 2001 Loans outstanding at end of year ................................ $ 8,424,728 $7,533,915 Daily average balance of loans and leases ................... $ 8,022,782 $6,884,694 Balance of allowance for loan losses at beginning of year.................................................. $ Loans charged-off: Commercial, financial and agricultural.................... Real estate – mortgage ............................................. Consumer ................................................................. Leasing and other ..................................................... Total loans charged-off ............................................ 4,095 467 3,436 206 8,204 3,482 1,466 3,476 453 8,877 89,627 $ 77,700 $ 6,140,200 $ 5,295,459 $ 5,373,020 $ 5,527,092 $ 5,366,772 $ 5,341,497 $ 71,920 $ 71,872 $ 65,640 6,604 1,476 4,497 651 13,228 7,203 2,204 5,587 676 15,670 Recoveries of loans previously charged-off: Commercial, financial and agricultural.................... Real estate – mortgage ............................................. Consumer ................................................................. Leasing and other ..................................................... Total recoveries........................................................ Net loans charged-off................................................... Provision for loan losses .............................................. Allowance purchased ................................................... Balance at end of year.................................................. $ 2,042 2,705 906 1,245 1,496 1,169 76 77 4,520 5,196 4,357 3,008 4,717 3,120 11,567 3,108 92,847 $ 89,627 1,210 711 1,811 97 3,829 9,399 9,705 5,474 77,700 $ 842 669 2,251 56 3,818 11,852 11,900 - 71,920 $ $ 6,296 767 6,683 529 14,275 703 364 2,683 87 3,837 10,438 14,585 2,085 71,872 Selected Asset Quality Ratios: Net charge-offs to average loans.................................. Allowance for loan losses to loans outstanding at end of year ....................................... Non-performing assets (1) to total assets ..................... Non-accrual loans to total loans................................... (1) Includes accruing loans past due 90 days or more. 0.04% 0.06% 0.17% 0.22% 0.20% 1.10% 0.38% 0.43% 1.19% 0.30% 0.30% 1.27% 0.33% 0.37% 1.36% 0.47% 0.45% 1.34% 0.44% 0.42% 13 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following table presents the aggregate amount of non-accrual and past due loans and other real estate owned (3): 2005 2004 December 31 2003 (in thousands) 2002 2001 Non-accrual loans (1) (2).................................... $ 36,560 $ 22,574 $ 22,422 $ 24,090 $ 22,794 Accruing loans past due 90 days or more........... 9,368 9,012 Other real estate .................................................. 1,817 2,072 Totals.............................................................. $ 47,644 $ 33,101 $ 32,616 $ 39,123 $ 33,979 14,095 938 8,318 2,209 9,609 585 (1) As of December 31, 2005, the additional interest income that would have been recorded during 2005 if non-accrual loans had been current in accordance with their original terms was approximately $3.0 million. The amount of interest income on non-accrual loans that was included in 2005 income was approximately $2.2 million. (2) Accrual of interest is generally discontinued when a loan becomes 90 days past due as to principal and interest. When interest accruals are discontinued, interest credited to income is reversed. Non-accrual loans are restored to accrual status when all delinquent principal and interest becomes current or the loan is considered secured and in the process of collection. Certain loans, primarily residential mortgages, that are determined to be sufficiently collateralized may continue to accrue interest after reaching 90 days past due. (3) Excluded from the amounts presented at December 31, 2005 are $132.3 million in loans where possible credit problems of borrowers have caused management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms. These loans are considered to be impaired under Statement 114, but continue to pay according to their contractual terms and are therefore not included in non-performing loans. Non-accrual loans include $13.2 million of impaired loans. The following table summarizes the allocation of the allowance for loan losses by loan type: 2005 2004 December 31 2003 (dollars in thousands) 2002 2001 % of Loans in Each Allowance Category Allowance Category Allowance Category Allowance Category Allowance Category % of Loans in Each % of Loans in Each % of Loans in Each % of Loans in Each Comm’l, financial & agriculture ...... $ 52,379 Real estate – Mortgage ........... Consumer, leasing & other ............... Unallocated ............. 7,935 14,931 Totals.................. $ 92,847 17,602 28.2% $ 43,207 30.1% $ 34,247 31.7% $ 33,130 31.6% $ 22,531 27.8% 64.7 19,784 62.5 14,471 59.0 13,099 56.8 19,018 58.9 7.1 - 100.0% 16,289 10,347 $ 89,627 7.4 - 100.0% 16,279 12,703 $ 77,700 9.3 - 100.0% 14,178 11,513 $ 71,920 11.6 - 100.0% 10,855 19,468 $ 71,872 13.3 - 100.0% The provision for loan losses decreased $1.6 million from $4.7 million in 2004 to $3.1 million in 2005, after decreasing $5.0 million in 2004. These decreases resulted from the continued improvement in the Corporation’s asset quality, as reflected in lower net charge- offs. Net charge-offs as a percentage of average loans were 0.04% in 2005, a two basis point decrease from 0.06% in 2004, which was an 11 basis point decrease from 2003. Total net charge-offs of $3.0 million in 2005 and $4.4 million in 2004 approximated the amounts recorded for the provision for loan losses in those years. Non-performing assets as a percentage of total assets increased slightly from 0.30% at December 31, 2004 to 0.38% at December 31, 2005, after decreasing three basis points in 2004. While the 14 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation non-performing assets ratio increased eight basis points in comparison to 2004, the level of non-performing assets was still relatively low in absolute terms. The provision for loan losses is determined by the allowance allocation process, whereby an estimated “need” is allocated to impaired loans as defined in Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan”, or to pools of loans under Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies”. The allocation is based on risk factors, collateral levels, economic conditions and other relevant factors, as appropriate. The Corporation also maintains an unallocated allowance, which was approximately 16% at December 31, 2005. The unallocated allowance is used to cover any factors or conditions that might exist at the balance sheet date, but are not specifically identifiable. Management believes such an unallocated allowance is reasonable and appropriate as the estimates used in the allocation process are inherently imprecise. See additional disclosures in Note A, “Summary of Significant Accounting Policies”, in the Notes to Consolidated Financial Statements and “Critical Accounting Policies”, in Management’s Discussion. Management believes that the allowance balance of $92.8 million at December 31, 2005 is sufficient to cover losses inherent in the loan portfolio on that date and is appropriate based on applicable accounting standards. Other Income and Expenses 2005 vs. 2004 Other Income The following table presents the components of other income for the past two years: 2005 Increase (decrease) % $ 2004 (dollars in thousands) Investment management and trust services .... $ Service charges on deposit accounts ............... Other service charges and fees ........................ Gain on sale of loans........................................ Gain on sale of deposits................................... Investment securities gains .............................. Other ................................................................ Total ............................................................ $ 35,669 40,198 24,200 25,468 2,200 6,625 9,908 144,268 $ $ 34,817 39,451 20,494 19,262 - 17,712 7,128 138,864 $ $ 852 747 3,706 6,206 2,200 (11,087) 2,780 5,404 2.4% 1.9 18.1 32.2 N/A (62.6) 39.0 3.9% The following table presents the amounts included in the above totals which were contributed by acquisitions: 2005 2004 Increase (decrease) (in thousands) Investment management and trust services ............ $ Service charges on deposit accounts ....................... Other service charges and fees ................................ Gain on sale of loans................................................ Investment securities losses..................................... Other ........................................................................ Total ..................................................................... $ 1,446 1,410 877 17,422 (269) 4,076 24,962 $ $ 490 186 151 11,108 - 2,529 14,464 $ $ 956 1,224 726 6,314 (269) 1,547 10,498 As shown in the preceding table, recent acquisitions did not make a significant contribution to other income, except mortgage banking income, which is a significant line of business for Resource Bank. 15 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following table presents the components of other income for each of the past two years, excluding the amounts contributed by acquisitions: 2005 Increase (decrease) % $ 2004 (dollars in thousands) Investment management and trust services .... $ Service charges on deposit accounts ............... Other service charges and fees ........................ Gain on sale of loans........................................ Gain on sale of deposits................................... Investment securities gains .............................. Other ................................................................ Total ............................................................ $ 34,223 38,788 23,323 8,046 2,200 6,894 5,832 119,306 $ $ 34,327 39,265 20,343 8,154 - 17,712 4,599 124,400 $ $ (104) (477) 2,980 (108) 2,200 (10,818) 1,233 (5,094) (0.3)% (1.2) 14.6 (1.3) N/A (61.1) 26.8 (4.1)% The discussion that follows, unless otherwise noted, addresses changes in other income, excluding acquisitions. In 2005, total other income decreased $5.1 million, or 4.1%. Excluding investment securities gains, other income increased $5.7 million, or 5.4%. Investment management and trust services decreased slightly by $104,000, or 0.3%. The 2005 decrease was due to brokerage revenue decreasing $242,000, or 2.0%, offset by trust commission income increasing $138,000, or 0.6%. Total service charges on deposit accounts decreased $477,000, or 1.2%. The decrease was due to the Corporation reducing service charges on deposit accounts in an effort to remain competitive and the impact of rising interest rates on commercial deposit account service charge credits. This decrease was offset by increases in overdraft and cash management fees. Overdraft fees increased $778,000, or 4.7%, and cash management fees increased $229,000, or 3.0%. During 2005, the rising interest rate environment began to make cash management services more attractive for business customers. Other service charges and fees increased $3.0 million, or 14.6%. The increase was driven by growth in letter of credit fees ($553,000 or 15.6%, increase), merchant fees ($2.2 million, or 44.4%, increase) and debit card fees ($712,000, or 12.6%, increase). The growth in merchant fees resulted from a one-time fee adjustment and continued penetration in new markets. Debit card fees increased due to increased volume. Gains on sales of loans decreased only $108,000, or 1.3%, as overall volumes remained strong despite a slight increase in longer-term mortgage rates. Other income increased $1.2 million, or 26.8%, due to growth in net servicing income on mortgage loans and gains on sales of other real estate owned. The gain on sale of deposits resulted from the Corporation selling three branches and related deposits in two separate transactions during the second quarter of 2005. Virtually the entire $2.2 million gain resulted from the premiums received on the $36.7 million of deposits sold. Including the impact of acquisitions, investment securities gains decreased $11.1 million, or 62.6%, in 2005. Investment securities gains included realized gains on the sale of equity securities of $5.8 million in 2005, down from $14.8 million in 2004, reflecting the general decline in the equity markets and bank stocks in particular, and $843,000 and $3.1 million in 2005 and 2004, respectively, on the sale of debt securities, which were generally sold to take advantage of the interest rate environment. 16 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation Other Expenses The following table presents the components of other expenses for each of the past two years: 2005 2004 (dollars in thousands) $ Increase % Salaries and employee benefits ....................... $ Net occupancy expense .................................. Equipment expense ......................................... Data processing ............................................... Advertising ...................................................... Intangible amortization.................................... Other ............................................................... Total ............................................................ $ 181,889 29,275 11,938 12,395 8,823 5,311 66,660 316,291 $ $ 166,026 23,813 10,769 11,430 6,943 4,726 53,808 277,515 $ $ 15,863 5,462 1,169 965 1,880 585 12,852 38,776 9.6% 22.9 10.9 8.4 27.1 12.4 23.9 14.0% The following table presents the amounts included in the above totals which were contributed by acquisitions: 2005 2004 (in thousands) Increase Salaries and employee benefits ....................... $ Net occupancy expense .................................. Equipment expense ......................................... Data processing ............................................... Advertising ...................................................... Intangible amortization.................................... Other ............................................................... Total ............................................................ $ 28,215 5,620 2,662 2,005 1,357 1,751 15,964 57,574 $ $ 13,371 1,986 1,097 716 633 381 5,331 23,515 $ $ 14,844 3,634 1,565 1,289 724 1,370 10,633 34,059 The following table presents the components of other expenses for each of the past two years, excluding the amounts contributed by acquisitions: 2005 Increase (decrease) % $ 2004 (dollars in thousands) Salaries and employee benefits ....................... $ Net occupancy expense .................................. Equipment expense ......................................... Data processing ............................................... Advertising ...................................................... Intangible amortization.................................... Other ............................................................... Total ............................................................ $ 153,674 23,655 9,276 10,390 7,466 3,560 50,696 258,717 $ $ 152,655 21,827 9,672 10,714 6,310 4,345 48,477 254,000 $ $ 1,019 1,828 (396) (324) 1,156 (785) 2,219 4,717 0.7% 8.4 (4.1) (3.0) 18.3 (18.1) 4.6 1.9% The discussion that follows addresses changes in other expenses, excluding acquisitions. Salaries and employee benefits increased $1.0 million, or 0.7%, in 2005, with the salary expense component increasing $856,000, or 0.7%. The increase was driven by normal salary increases for existing employees and a slight increase in the number of full-time 17 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION employees, offset by a decrease in stock-based compensation expense from $3.9 million in 2004 to $1.0 million in 2005. The decrease in stock-based compensation expense was primarily due to a change in vesting for stock options from 100% vesting for the 2004 grant to a three-year vesting period for the 2005 grant. See additional discussion in Note M, “Stock-Based Compensation Plans and Shareholders’ Equity”, in the Notes to Consolidated Financial Statements. Employee benefits increased $163,000, or 0.6%, due primarily to increased retirement plan expenses, offset by lower healthcare expenses as the Corporation changed to a lower cost healthcare provider in 2005. See additional discussion of certain retirement plans in Note L, “Employee Benefit Plans”, in the Notes to Consolidated Financial Statements. Net occupancy expense increased $1.8 million, or 8.4%. The increase resulted from the expansion of the branch network and the addition of new office space for certain affiliates. Equipment expense decreased $396,000, or 4.1%, in 2005, due to lower depreciation expense for equipment as items became fully depreciated, offset partially by increases due to additions for branch network and office expansions. Data processing expense decreased $324,000, or 3.0%, reflecting the Corporation’s success over the past few years in renegotiating key processing contracts with certain vendors, most notably an automated teller service provider in 2005. Advertising expense increased $1.2 million, or 18.3%, mainly due to growth in retail promotional campaigns. Intangible amortization decreased $785,000, or 18.1%. Intangible amortization consists of the amortization of unidentifiable intangible assets related to branch and loan acquisitions, core deposit intangible assets and other identified intangible assets. The decrease in 2005 was related to lower amortization related to core deposit intangible assets, which are amortized on an accelerated basis over the estimated life of the acquired core deposits. Other expense increased $2.2 million, or 4.6%, in 2005 mainly due to a $2.2 million legal reserve recorded during the fourth quarter of 2005 related to a settlement of a lawsuit, which is subject to court approval. The suit alleged that Resource Bank violated the Telephone Consumer Protection Act (TCPA), prior to being acquired by Fulton Financial in April 2004. For further details, see Note O, “Commitments and Contingencies”, in the Notes to Consolidated Financial Statements. 2004 vs. 2003 Other Income Total other income increased $4.5 million, or 3.3%, from $134.4 million in 2003 to $138.9 million in 2004. Excluding investment securities gains, other income increased $6.6 million, or 5.8%, in 2004. The acquisition of Resource contributed $14.4 million to total other income in 2004. Premier did not have a significant impact on other income growth in 2004. The discussion that follows, unless otherwise noted, addresses changes in other income, excluding acquisitions. Investment management and trust services income grew $68,000, or 0.2%, in 2004. Brokerage revenue increased $484,000, or 4.1%, while trust commission income decreased $416,000, or 1.9%. Total service charges on deposit accounts increased $566,000, or 1.5%, in 2004. Overdraft fees increased $979,000, or 6.4%, and cash management fees increased only $39,000, or 0.5%, due to the low interest rate environment making cash management services less attractive for smaller business customers. Other service charges and fees increased $1.4 million, or 7.2%, in 2004. The increase was driven by growth in letter of credit fees, merchant fees and debit card fees. Letter of credit fees increased $104,000, or 3.1%, and merchant fees increased $370,000, or 8.2%, all as a result of an increased focus on growing these business lines. Debit card fees increased $494,000, or 9.7%, due to an increase in transaction volume. Gains on sales of loans decreased $10.8 million, or 57.0%. The decrease was due to the increase in interest rates from their historic lows and the resulting reduction in the level of mortgage refinancing activity. Other income increased $254,000, or 6.0%, in 2004. Including the impact of acquisitions, investment securities gains decreased $2.1 million, or 10.8%. Investment securities gains included realized gains on the sale of equity securities of $14.8 million, reflecting the general improvement in the equity markets and 18 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation bank stocks in particular, and $3.1 million on the sale of debt securities, which were generally sold to take advantage of the interest rate environment. These gains were offset by write-downs of $137,000 in 2004 for specific equity securities deemed to exhibit other than temporary impairment in value. Other Expenses Total other expenses increased $43.9 million, or 18.8%, in 2004, including $30.0 million due to acquisitions. The discussion that follows addresses changes in other expenses, excluding acquisitions. Salaries and employee benefits increased $11.5 million, or 8.5%. The salary expense component increased $6.4 million, or 5.7%, driven by normal salary increases for existing employees, as total average full-time equivalent employees remained relatively consistent at approximately 2,900. Employee benefits increased $5.1 million, or 21.7%, driven mainly by increases in healthcare costs and retirement plan expenses. Net occupancy expense increased $1.4 million, or 7.0%, to $20.9 million. The increase resulted from the expansion of the branch network and the addition of new office space for certain affiliates. Equipment expense decreased $1.0 million, or 9.9%, mainly in depreciation, as certain equipment became fully depreciated. Data processing expense decreased $651,000, or 5.8%, due to the successful renegotiation of key processing contracts with certain vendors. Advertising expense decreased $76,000, or 1.3%, due to efforts to control these discretionary expenses. Intangible amortization increased $1.7 million, or 116.4%. The increase in 2004 primarily resulted from the amortization of intangible assets related to the acquisition of an agriculture loan portfolio in December 2003. Other expense increased $916,000, or 2.1%, as a result of compliance costs associated with the provisions of the Sarbanes-Oxley Act of 2002. These costs were realized in external audit fees, which increased from $363,000 in 2003 to $1.6 million in 2004, as well as an additional $400,000 in consulting expense during 2004. These cost increases were offset by reductions in operating risk loss, other real estate expenses and legal fees. Income Taxes Income taxes increased $6.7 million, or 10.3%, in 2005 and $5.6 million, or 9.5%, in 2004. The Corporation’s effective tax rate (income taxes divided by income before income taxes) remained fairly stable at 30.1%, 30.2% and 30.2% in 2005, 2004 and 2003, respectively. In general, the variances from the 35% Federal statutory rate consisted of tax-exempt interest income and investments in low and moderate income housing partnerships (LIH Investments), which generate Federal tax credits. Net credits were $4.9 million, $4.5 million and $4.0 million in 2005, 2004 and 2003, respectively. For additional information regarding income taxes, see Note K, “Income Taxes”, in the Notes to Consolidated Financial Statements. 19 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION FINANCIAL CONDITION Total assets increased $1.2 billion, or 11.1%, to $12.4 billion at December 31, 2005, from $11.2 billion at December 31, 2004. Excluding the SVB acquisition in July 2005, total assets increased $650.5 million, or 5.8%. During 2005, increases in deposits and proceeds from short and long-term borrowings were used to fund loan growth. Total loans, net of the allowance for loan losses, increased $887.6 million, or 11.9% ($585.9 million, or 7.9%, excluding the acquisition of SVB). Total deposits increased $909.3 million, or 11.5%, to $8.8 billion at December 31, 2005 ($435.8 million, or 5.5%, excluding the acquisition of SVB), and total borrowings increased $280.5 million, or 14.9% ($255.8 million, or 13.6%, excluding the acquisition of SVB). The table below presents a condensed ending balance sheet for the Corporation, adjusted for the balances recorded for the 2005 acquisition of SVB, in comparison to 2004 ending balances. 2005 2004 Increase (decrease) (3) Fulton Financial Corporation (As Reported) SVB Financial Services, Inc. (1) Fulton Financial Corporation (2) Fulton Financial Corporation (dollars in thousands) $ % Assets: Cash and due from banks ........... $ Other earning assets.................... Investment securities .................. Loans, net allowance .................. Premises and equipment ............. Goodwill and intangible assets... Other assets ................................ 368,043 275,310 2,562,145 8,331,881 170,254 448,422 245,500 $ $ 20,035 61,046 124,916 301,660 9,345 63,273 10,608 $ 348,008 214,264 2,437,229 8,030,221 160,909 385,149 234,892 $ 278,065 246,192 2,449,859 7,444,288 146,911 389,322 205,511 69,943 (31,928) (12,630) 585,933 13,998 (4,173) 29,381 25.2% (13.0) (0.5) 7.9 9.5 (1.1) 14.3 Total Assets .............................. $ 12,401,555 $ 590,883 $ 11,810,672 $ 11,160,148 $ 650,524 5.8% Liabilities and Shareholders’ Equity: Deposits...................................... $ Short-term borrowings ............... Long-term debt ........................... Other liabilities ........................... 8,804,839 1,298,962 860,345 154,438 $ 473,490 - 24,710 2,290 $ 8,331,349 1,298,962 835,635 152,148 $ 7,895,524 1,194,524 684,236 141,777 $ 435,825 104,438 151,399 10,371 5.5% 8.7 22.1 7.3 Total Liabilities ........................ 11,118,584 500,490 10,618,094 9,916,061 $ 702,033 7.1 Shareholders’ equity..................... 1,282,971 90,393 1,192,578 1,244,087 (51,509) (4.1) Total Liabilities and Shareholders’ Equity.............. $ 12,401,555 $ 590,883 $ 11,810,672 $ 11,160,148 $ 650,524 5.8% (1) Balances recorded for the July 1, 2005 acquisition of SVB Financial Services, Inc. (2) Excluding balances recorded for SVB Financial Services, Inc. (3) Fulton Financial Corporation, excluding balances recorded for SVB Financial Services, Inc. as compared to 2004. 20 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation Loans The following table presents loans outstanding, by type, as of the dates shown: 2005 2004 December 31 2003 (in thousands) 2002 2001 Commercial – industrial and financial...... $ Commercial – agricultural ........................ Real-estate – commercial mortgage.......... Real-estate – residential mortgage and home equity.......................................... Real-estate – construction......................... Consumer .................................................. Leasing and other...................................... Unearned income ...................................... Totals ................................................... $ 2,044,010 331,659 2,831,405 1,774,260 851,451 519,094 79,738 8,431,617 (6,889) 8,424,728 $ 1,946,962 326,176 2,461,016 $ 1,594,451 354,517 1,992,650 $ 1,489,990 189,110 1,527,143 $ 1,341,280 154,100 1,428,066 1,651,321 595,567 486,877 72,795 7,540,714 (6,799) $ 7,533,915 1,324,612 307,108 496,793 77,646 6,147,777 (7,577) $ 6,140,200 1,244,783 248,565 521,431 84,063 5,305,085 (9,626) $ 5,295,459 1,468,799 267,627 626,985 98,823 5,385,680 (12,660) $ 5,373,020 Total loans, net of unearned income, increased $890.9 million, or 11.8%, in 2005 ($586.0 million, or 7.8%, excluding the acquisition of SVB). The internal growth of $586.0 million included increases in total commercial loans ($31.5 million, or 1.4%), commercial mortgage loans ($196.1 million, or 8.0%), construction loans ($255.9 million, or 43.0%), and residential mortgage and home equity loans ($94.0 million, or 5.7%). In 2004, total loans, net of unearned income, increased $1.4 billion, or 22.7% ($521.7 million, or 8.5%, excluding the 2004 acquisitions of Resource and First Washington). The internal growth of $521.7 million included increases in total commercial loans ($148.5 million, or 7.6%), commercial mortgage loans ($183.7 million, or 9.2%), construction loans ($11.5 million, or 3.8%), and residential mortgages and home equity loans ($235.0 million, or 17.7%), offset partially by decreases in consumer loans ($50.0 million, or 10.0%) and leasing and other loans ($4.9 million, or 6.2%). In both 2005 and 2004, the Corporation experienced strong overall loan growth as a result of favorable economic conditions and interest rates. Investment Securities The following table presents the carrying amount of investment securities held to maturity (HTM) and available for sale (AFS) as of the dates shown: HTM 2005 AFS Total HTM December 31 2004 AFS (in thousands) Total HTM 2003 AFS Total Equity securities ......................... $ U.S. Government securities ........ U.S. Government sponsored agency securities........................ State and municipal..................... Corporate debt securities ............ Mortgage-backed securities ........ Totals .................................... $ - - $ 135,532 35,118 $ 135,532 35,118 $ - - $ 170,065 68,449 $ 170,065 $ 68,449 - $ 212,352 76,422 - $ 212,352 76,422 7,512 5,877 - 4,869 18,258 205,182 438,987 65,834 1,663,234 $ 2,543,887 212,694 444,864 65,834 1,668,103 $ 2,562,145 $ 6,903 10,658 650 6,790 25,001 60,476 332,455 71,127 1,722,286 $ 2,424,858 67,379 343,113 71,777 1,729,076 $ 2,449,859 $ 6,017 7,728 298,030 4,462 28,656 640 10,163 2,282,680 22,993 $2,904,157 13,745 302,492 29,296 2,292,843 $ 2,927,150 21 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Total investment securities increased $112.3 million, or 4.6% (decreased $12.6 million, or 0.5%, excluding the acquisition of SVB), to a balance of $2.6 billion at December 31, 2005. In 2004, investment securities decreased $477.3 million, or 16.3%, to reach a balance of $2.4 billion. The decrease in 2004 resulted from maturities and prepayments that were not reinvested due to rising short- term interest rates. The Corporation classified 99.3% of its investment portfolio as available for sale at December 31, 2005 and, as such, these investments were recorded at their estimated fair values. As short-term interest rates increased throughout the year, the net unrealized loss on non-equity available for sale investment securities increased $38.8 million from a net unrealized loss of $21.1 million at December 31, 2004 to a net unrealized loss of $59.9 million at December 31, 2005. At December 31, 2005, equity securities consisted of Federal Home Loan Bank (FHLB) and other government agency stock ($57.3 million), stocks of other financial institutions ($71.0 million) and mutual funds ($7.2 million). The bank stock portfolio has historically been a source of capital appreciation and realized gains ($5.8 million in 2005, $14.8 million in 2004 and $17.3 million in 2003). Management periodically sells bank stocks when, in its opinion, valuations and market conditions warrant such sales. Other Assets Cash and due from banks increased $90.0 million, or 32.4% ($69.9 million, or 25.2%, excluding the acquisition of SVB), in 2005, following a $22.9 million, or 7.6%, decrease in 2004. Because of the daily fluctuations that result in the normal course of business, cash is more appropriately analyzed in terms of average balances. On an average balance basis, cash and due from banks increased $30.4 million, or 9.6%, from $316.2 million in 2004 to $346.5 million in 2005, following a $36.2 million, or 12.9%, increase in 2004. The increase in both years resulted from acquisitions and growth in the Corporation’s branch network. Premises and equipment increased $23.3 million, or 15.9%, in 2005 to $170.3 million, which included $9.3 million as a result of the acquisition of SVB. The remaining increase reflects additions primarily for the construction of various new branch and office facilities. Goodwill and intangible assets increased $59.1 million, or 15.2%, in 2005 primarily due to the acquisition of SVB, following a $244.5 million, or 168.9%, increase in 2004, also as a result of acquisitions. Other assets increased $40.0 million, or 19.5%, in 2005 to $245.5 million, including $10.6 million as a result of the acquisition of SVB. The increase in other assets was due primarily to an increase in the net deferred tax asset due to increases in unrealized losses on investment securities, an increase in accrued interest receivable related to increases in loans and interest rates, and the additional funding of the defined benefit pension plan in 2005, offset by a decrease in LIH Investments due to amortization of existing investments. Deposits and Borrowings Deposits increased $909.3 million, or 11.5%, to $8.8 billion at December 31, 2005 ($435.8 million, or 5.5%, excluding the acquisition of SVB). This compares to an increase of $1.1 billion, or 16.9%, in 2004 ($118.9 million, or 1.8%, excluding the 2004 acquisitions of Resource and First Washington). As in the prior year, the trend during the first half of 2005 was strong growth in core demand and savings accounts, offset by declines in time deposits. In the second half of 2005, consumers began increasing investments in time deposits due to rising long-term rates, resulting in an overall increase in time deposits for 2005. If longer-term rates continue to increase in the future, a shift in deposit funds to higher cost time deposits could occur. During 2005, total demand deposits increased $300.4 million, or 10.0% ($147.5 million, or 4.9%, excluding the acquisition of SVB), savings deposits increased $208.3 million, or 10.9% ($36.5 million, or 1.9%, excluding the acquisition of SVB), and time deposits increased $400.7 million, or 13.5% ($251.9 million, or 8.5%, excluding the acquisition of SVB). During 2004, demand deposits increased $457.1 million, or 17.9% ($234.6 million, or 10.8%, excluding the 2004 acquisitions of Resource and First Washington), savings deposits increased $165.7 million, or 9.5% ($58.7 million, or 3.8%, excluding the 2004 acquisitions of Resource and First Washington), and time deposits increased $520.9 million, or 21.3% (decrease of $174.5 million, or 7.2%, excluding the 2004 acquisitions of Resource and First Washington). The trend in 2004 was strong growth in core demand and 22 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation savings accounts due to consumers favoring banks over the equity markets. In addition, the relatively low interest rate environment resulted in consumers favoring demand and savings products over time deposits, as incremental long-term rates were not attractive. Short-term borrowings, which consist mainly of Federal funds purchased and customer cash management accounts, increased $104.4 million, or 8.7%, in 2005 after decreasing $202.2 million, or 14.5%, in 2004 ($329.9 million, or 23.6%, excluding the 2004 acquisitions of Resource and First Washington). The increase in 2005 was due to purchases of Federal funds as loan growth outpaced deposit increases, offset by decreases in customer cash management accounts. In 2004, the decrease was due to strategies to reduce overnight Federal funds purchased in a rising rate environment. Long-term debt increased $176.1 million, or 25.7% ($151.4 million, or 22.1%, excluding the acquisition of SVB), primarily due to the Corporation’s issuance of $100.0 million of ten-year subordinated notes in March 2005, and partially due to an increase in Federal Home Loan Bank advances. Other Liabilities Other liabilities increased $12.7 million, or 8.9% ($10.4 million, or 7.3%, excluding the acquisition of SVB), following a $38.6 million, or 37.5%, increase in 2004. The increase in 2005 was primarily attributable to an increase in dividends payable to shareholders ($3.0 million), an increase in the fair value of derivative financial instruments ($5.9 million), and the additional legal accrual for the TCPA lawsuit ($2.2 million). The increase in 2004 was primarily attributable to additional equity commitments for low-income housing projects ($9.2 million increase), an increase in accrued retirement benefits ($2.4 million) and an increase in dividends payable to shareholders ($2.5 million). Shareholders’ Equity Total shareholders’ equity increased $38.9 million, or 3.1%, to $1.3 billion, or 10.3% of ending total assets, as of December 31, 2005. This growth was due primarily to 2005 net income of $166.1 million, offset by dividends to shareholders of $88.5 million. In addition, equity increased $66.6 million for stock issued for the SVB acquisition, decreased $85.2 million for treasury stock purchases, and decreased $30.5 million as a result of increased unrealized losses on investment securities. The Corporation periodically implements stock repurchase plans for various corporate purposes. In addition to evaluating the financial benefits of implementing repurchase plans, management also considers liquidity needs, the current market price per share and regulatory limitations. In 2002, the Board of Directors approved a stock repurchase plan for 7.3 million shares, which was extended through June 30, 2004. During 2004, 1.6 million shares were repurchased under this plan. On June 15, 2004, the Board of Directors approved a stock repurchase plan for 5.0 million shares through December 31, 2004. During 2004, 3.1 million shares were repurchased under this plan, including 1.3 million shares acquired under an “Accelerated Share Repurchase” program (ASR). On December 21, 2004, the Board of Directors extended the stock repurchase plan through June 30, 2005 and increased the total number of shares that could be repurchased to 5.0 million. No shares were purchased under this extended plan in 2004. During 2005, 4.3 million shares were repurchased under this plan through an ASR. Under an ASR, the Corporation repurchases shares immediately from an investment bank rather than over time. The investment bank, in turn, repurchases shares on the open market over a period that is determined by the average daily trading volume of the Corporation’s shares, among other factors. For the ASR in effect at December 31, 2005, which was implemented in the second quarter of 2005, the Corporation settled its position with the investment bank at the termination of the ASR by paying cash in an amount representing the difference between the initial prices paid and the actual price of the shares repurchased. The Corporation completed the ASR in February of 2006, and paid the investment bank a total of $3.4 million for this difference. The Corporation and its subsidiary banks are subject to regulatory capital requirements administered by various banking regulators. Failure to meet minimum capital requirements can initiate certain actions by regulators that could have a material effect on the Corporation’s financial statements. The regulations require that banks maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and Tier I capital to average assets (as defined). As of December 31, 2005, the Corporation and each of its bank subsidiaries met the minimum capital requirements. In addition, the Corporation and each of its bank subsidiaries’ capital ratios exceeded the amounts required to be considered “well-capitalized” as defined in the regulations. See also Note J, “Regulatory Matters”, in the Notes to Consolidated Financial Statements. 23 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Contractual Obligations and Off-Balance Sheet Arrangements The Corporation has various financial obligations that require future cash payments. These obligations include the payment of liabilities recorded on the Corporation’s balance sheet as well as contractual obligations for purchased services or for operating leases. The following table summarizes significant contractual obligations to third parties, by type, that are fixed and determinable at December 31, 2005: One Year or Less One to Three Years Payments Due In Three to Five Years (in thousands) Over Five Years Total Deposits with no stated maturity (a).. $ 5,435,119 Time deposits (b)............................... 1,894,744 Short-term borrowings (c)................. 1,298,962 33,734 Long-term debt (c) ............................ 10,437 Operating leases (d)........................... 13,719 Purchase obligations (e) .................... $ - 969,418 - 289,282 17,356 25,736 $ - 211,047 - 128,238 11,329 14,349 $ - 294,511 - 409,091 33,186 - $ 5,435,119 3,369,720 1,298,962 860,345 72,308 53,804 (a) Includes demand deposits and savings accounts, which can be withdrawn by customers at any time. (b) See additional information regarding time deposits in Note H, “Deposits”, in the Notes to Consolidated Financial Statements. (c) See additional information regarding borrowings in Note I, “Short-Term Borrowings and Long-Term Debt”, in the Notes to Consolidated Financial Statements. (d) See additional information regarding operating leases in Note N, “Leases”, in the Notes to Consolidated Financial Statements. (e) Includes significant information technology, telecommunication and data processing outsourcing contracts. Variable obligations, such as those based on transaction volumes, are not included. In addition to the contractual obligations listed in the preceding table, the Corporation is a party to financial instruments with off- balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit and interest rate risk that are not recognized in the consolidated balance sheets. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments issued to guarantee the financial or performance obligation of a customer to a third party. Commitments and standby letters of credit do not necessarily represent future cash needs as they may expire without being drawn. The following table presents the Corporation’s commitments to extend credit and letters of credit as of December 31, 2005 (in thousands): Commercial mortgage, construction and land development............ $ 829,769 494,872 Home equity .................................................................................... 382,415 Credit card ....................................................................................... Commercial and other...................................................................... 2,028,997 Total commitments to extend credit ........................................... $ 3,736,053 Standby letters of credit ................................................................... $ 599,191 Commercial letters of credit ............................................................ 23,037 Total letters of credit................................................................... $ 622,228 24 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation CRITICAL ACCOUNTING POLICIES The following is a summary of those accounting policies that the Corporation considers to be most important to the portrayal of its financial condition and results of operations, as they require management’s most difficult judgments as a result of the need to make estimates about the effects of matters that are inherently uncertain. Allowance and Provision for Loan Losses – The Corporation accounts for the credit risk associated with its lending activities through the allowance and provision for loan losses. The allowance is an estimate of the losses inherent in the loan portfolio as of the balance sheet date. The provision is the periodic charge to earnings, which is necessary to adjust the allowance to its proper balance. On a quarterly basis, the Corporation assesses the adequacy of its allowance through a methodology that consists of the following: - Identifying loans for individual review under Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan” (Statement 114). In general, these consist of large balance commercial loans and commercial mortgages that are rated less than “satisfactory” based upon the Corporation’s internal credit-rating process. - Assessing whether the loans identified for review under Statement 114 are “impaired”. That is, whether it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. - For loans identified as impaired, calculating the estimated fair value, using observable market prices, discounted cash flows or the value of the underlying collateral. - Classifying all non-impaired large balance loans based on credit risk ratings and allocating an allowance for loan losses based on appropriate factors, including recent loss history for similar loans. - Identifying all smaller balance homogeneous loans for evaluation collectively under the provisions of Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (Statement 5). In general, these loans include residential mortgages, consumer loans, installment loans, smaller balance commercial loans and mortgages and lease receivables. - Statement 5 loans are segmented into groups with similar characteristics and an allowance for loan losses is allocated to each segment based on recent loss history and other relevant information. - Reviewing the results to determine the appropriate balance of the allowance for loan losses. This review gives additional consideration to factors such as the mix of loans in the portfolio, the balance of the allowance relative to total loans and non- performing assets, trends in the overall risk profile of the portfolio, trends in delinquencies and non-accrual loans and local and national economic conditions. - An unallocated allowance is maintained to recognize the inherent imprecision in estimating and measuring loss exposure. - Documenting the results of its review in accordance with SAB 102. The allowance review methodology is based on information known at the time of the review. Changes in factors underlying the assessment could have a material impact on the amount of the allowance that is necessary and the amount of provision to be charged against earnings. Such changes could impact future results. Accounting for Business Combinations – The Corporation accounts for all business acquisitions using the purchase method of accounting as required by Statement of Financial Accounting Standards No. 141, “Business Combinations” (Statement 141). Purchase accounting requires the purchase price to be allocated to the estimated fair values of the assets acquired and liabilities assumed. It also requires assessing the existence of and, if necessary, assigning a value to certain intangible assets. The remaining excess purchase price over the fair value of net assets acquired is recorded as goodwill. The purchase price is established as the value of securities issued for the acquisition, cash consideration paid and certain acquisition- related expenses. The fair values of assets acquired and liabilities assumed are typically established through appraisals, observable market values or discounted cash flows. Management has engaged independent third-party valuation experts to assist in valuing certain assets, particularly intangibles. Other assets and liabilities are generally valued using the Corporation’s internal asset/liability modeling system. The assumptions used and the final valuations, whether prepared internally or by a third party, are reviewed by 25 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION management. Due to the complexity of purchase accounting, final determinations of values can be time consuming and, occasionally, amounts included in the Corporation’s consolidated balance sheets and consolidated statements of income are based on preliminary estimates of value. Goodwill and Intangible Assets – Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (Statement 142) addresses the accounting for goodwill and intangible assets subsequent to acquisition. Intangible assets are amortized over their estimated lives. Some intangible assets have indefinite lives and are, therefore, not amortized. All intangible assets must be evaluated for impairment if certain events occur. Any impairment write-downs are recognized as expense in the consolidated income statement. Goodwill is not amortized to expense, but is evaluated at least annually for impairment. The Corporation completes its annual goodwill impairment test as of October 31st of each year. The Corporation tests for impairment by first allocating its goodwill and other assets and liabilities, as necessary, to defined reporting units. A fair value is then determined for each reporting unit. If the fair values of the reporting units exceed their book values, no write-down of the recorded goodwill is necessary. If the fair values are less than the book values, an additional valuation procedure is necessary to assess the proper carrying value of the goodwill. The Corporation determined that no impairment write-offs were necessary during 2005, 2004 and 2003. Business unit valuation is inherently subjective, with a number of factors based on assumptions and management judgments. Among these are future growth rates for the reporting units, discount rates and earnings capitalization rates. Changes in assumptions and results due to economic conditions, industry factors and reporting unit performance and cash flow projections could result in different assessments of the fair values of reporting units and could result in impairment charges in the future. If an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount, an impairment test between annual tests is necessary. Such events may include adverse changes in legal factors or in the business climate, adverse actions by a regulator, unauthorized competition, the loss of key employees, or similar events. The Corporation has not performed an interim goodwill impairment test during the past three years as no such events have occurred. However, such an interim test could be necessary in the future. Income Taxes – The provision for income taxes is based upon income before income taxes, adjusted for the effect of certain tax- exempt income and non-deductible expenses. In addition, certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the applicable enacted marginal tax rate. The Corporation must also evaluate the likelihood that deferred tax assets will be recovered from future taxable income. If any such assets are not likely to be recovered, a valuation allowance must be recognized. The Corporation has determined that a valuation allowance is not required for deferred tax assets as of December 31, 2005, except in the case of deferred tax benefits related to state income tax net operating losses. The assessment of the carrying value of deferred tax assets is based on certain assumptions, changes in which could have a material impact on the Corporation’s financial statements. See also Note K, “Income Taxes”, in the Notes to Consolidated Financial Statements. Recent Accounting Pronouncements Note A, “Summary of Significant Accounting Policies”, in the Notes to Consolidated Financial Statements discusses the expected impact of recently issued accounting standards adopted by the Corporation. 26 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation MARKET RISK Market risk is the exposure to economic loss that arises from changes in the values of certain financial instruments. The types of market risk exposures generally faced by financial institutions include interest rate risk, equity market price risk, foreign currency risk and commodity price risk. Due to the nature of its operations, only equity market price risk and interest rate risk are significant to the Corporation. Equity Market Price Risk Equity market price risk is the risk that changes in the values of equity investments could have a material impact on the financial position or results of operations of the Corporation. The Corporation’s equity investments consist of common stocks of publicly traded financial institutions, U.S. Government sponsored agency stocks and money market mutual funds. The equity investments most susceptible to equity market price risk are the financial institutions stocks, which had a cost basis of approximately $72.6 million and a fair value of $71.0 million at December 31, 2005. Gross unrealized gains in this portfolio were approximately $2.0 million at December 31, 2005. Although the carrying value of the financial institutions stocks accounted only for 0.6% of the Corporation’s total assets, any unrealized gains in the portfolio represent a potential source of revenue. The Corporation has a history of realizing gains from this portfolio and, if values were to decline more significantly than the current year, this revenue could materially be impacted. Management continuously monitors the fair value of its equity investments and evaluates current market conditions and operating results of the companies. Periodic sale and purchase decisions are made based on this monitoring process. None of the Corporation’s equity securities are classified as trading. Future cash flows from these investments are not provided in the table on page 31 as such investments do not have maturity dates. The Corporation has evaluated, based on existing accounting guidance, whether any unrealized losses on individual equity investments constituted “other-than-temporary” impairment, which would require a write-down through a charge to earnings. Based on the results of such evaluations, the Corporation recorded write-downs of $65,000 in 2005, $137,000 in 2004 and $3.3 million in 2003 for specific equity securities which were deemed to exhibit other-than-temporary impairment in value. Through December 31, 2005, gains of approximately $2.5 million had been realized on the sale of investments previously written down and, as of December 31, 2005, the impaired securities still held in the portfolio had recovered approximately $286,000 of the original write-down amount. Additional impairment charges may be necessary depending upon the performance of the equity markets in general and the performance of the individual investments held by the Corporation. See also Note C, “Investment Securities”, in the Notes to Consolidated Financial Statements. In addition to the risk of changes in the value of its equity portfolio, the Corporation’s investment management and trust services revenue could also be impacted by fluctuations in the securities markets. A portion of the Corporation’s trust revenue is based on the value of the underlying investment portfolios. If securities markets contract, the Corporation’s revenue could be negatively impacted. In addition, the ability of the Corporation to sell its brokerage services is dependent, in part, upon consumers’ level of confidence in the outlook for rising securities prices. Interest Rate Risk, Asset/Liability Management and Liquidity Interest rate risk creates exposure in two primary areas. First, changes in rates have an impact on the Corporation’s liquidity position and could affect its ability to meet obligations and continue to grow. Second, movements in interest rates can create fluctuations in the Corporation’s net interest income and changes in the economic value of its equity. The Corporation employs various management techniques to minimize its exposure to interest rate risk. An Asset/Liability Management Committee (ALCO), consisting of key financial and senior management personnel, meets on a weekly basis. The ALCO is responsible for reviewing the interest rate sensitivity position of the Corporation, approving asset and liability management policies, and overseeing the formulation and implementation of strategies regarding balance sheet positions and earnings. The primary goal of asset/liability management is to address the liquidity and net interest income risks noted above. 27 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION From a liquidity standpoint, the Corporation must maintain a sufficient level of liquid assets to meet the ongoing cash flow requirements of customers, who, as depositors, may want to withdraw funds or who, as borrowers, need credit availability. Liquidity sources are found on both sides of the balance sheet. Liquidity is provided on a continuous basis through scheduled and unscheduled principal reductions and interest payments on outstanding loans and investments. Liquidity is also provided through the availability of deposits and borrowings. The Corporation’s sources and uses of cash were discussed in general terms in the “Overview” section of Management’s Discussion. The consolidated statements of cash flows provide additional information. The Corporation generated $146.5 million in cash from operating activities during 2005, mainly due to net income. Investing activities resulted in a net cash outflow of $588.5 million, compared to a net cash inflow of $184.9 million in 2004. In 2005, reinvestments in the investment securities portfolio and the net increase in the loan portfolio exceeded proceeds from maturities and sales of investment securities. In 2004, funds provided by investment maturities and sales of investment securities were greater than the reinvestments in investment securities and the net increase in the loan portfolio. Financing activities resulted in net cash proceeds of $532.0 million in 2005, compared to a net cash usage of $384.7 million in 2004 as net funds were provided by increases in deposits, primarily time deposits as a result of increasing rates, as well as short-term borrowings and long-term debt. In 2004, funds provided by maturing investments were used to reduce short-term borrowings. Liquidity must also be managed at the Fulton Financial Corporation parent company level. For safety and soundness reasons, banking regulations limit the amount of cash that can be transferred from subsidiary banks to the Parent Company in the form of loans and dividends. Generally, these limitations are based on the subsidiary banks’ regulatory capital levels and their net income. Prior to 2004, the Parent Company had been able to meet its cash needs through normal, allowable dividends and loans. However, as a result of increased acquisition activity and stock repurchase plans, the Parent Company’s cash needs increased, requiring additional sources of funds. In 2005, the Corporation issued $100.0 million of ten-year subordinated notes, which mature April 1, 2015 and carry a fixed rate of 5.35%. Interest is paid semi-annually, commencing in October 2005. In 2004, the Parent Company entered into a revolving line of credit agreement with an unaffiliated bank. Under the terms of the agreement, the Parent Company can borrow up to $50.0 million with interest calculated at the one-month London Interbank Offering Rate (LIBOR) plus 0.27%. The credit agreement requires the Corporation to maintain certain financial ratios related to capital strength and earnings. As of December 31, 2005 there were no borrowings outstanding under the agreement. The Corporation was in compliance with all required covenants under the credit agreement as of December 31, 2005. In January 2006, the Corporation purchased all of the common stock of a new Delaware business trust, Fulton Capital Trust I, which was formed for the purpose of issuing $150.0 million of trust preferred securities at an effective rate of approximately 6.50%. In connection with this transaction the Parent Company issued $154.6 million of junior subordinated deferrable interest debentures to the trust. These debentures carry the same rate and mature on February 1, 2036. These borrowings, most notably the revolving line of credit agreement, supplement the liquidity available from subsidiaries through dividends and provide some flexibility in Parent Company cash management. Management continues to monitor the liquidity and capital needs of the Parent Company and will implement appropriate strategies, as necessary, to remain well-capitalized and to meet its cash needs. In addition to its normal recurring and operating cash needs, the Parent Company also paid cash for a portion of the Columbia Bancorp acquisition, which was completed on February 1, 2006. Based on the terms of the merger agreement, the Parent Company paid approximately $150 million in cash to consummate the acquisition. For further details, see Note Q, “Mergers and Acquisitions”, in the Notes to Consolidated Financial Statements. At December 31, 2005, liquid assets (defined as cash and due from banks, short-term investments, Federal funds sold, mortgages available for sale, securities available for sale, and non-mortgage-backed securities held to maturity due in one year or less) totaled $3.2 billion, or 25.5% of total assets. This compares to $3.0 billion, or 26.5% of total assets, at December 31, 2004. 28 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation The following tables present the maturities of investment securities at December 31, 2005 and the weighted average yields of such securities (calculated based on historical cost): HELD TO MATURITY (at amortized cost) MATURING Within One Year Yield Amount After One But Within Five Years Yield Amount After Five But Within Ten Years Yield Amount (dollars in thousands) After Ten Years Yield Amount U.S. Government sponsored agency securities.................... $ State and municipal (1)............... - 4,540 Totals....................................... $ 4,540 $ 7,512 - 3.95 991 3.95% $ 8,503 $ 3.98% 5.13 4.11% $ - 346 346 - 5.42 5.42% $ $ - - - - - - Mortgage-backed securities (2) .. $ 4,869 6.16% AVAILABLE FOR SALE (at estimated fair value) MATURING Within One Year Yield Amount After One But Within Five Years Yield Amount After Five But Within Ten Years Yield Amount (dollars in thousands) - $ - After Ten Years Yield Amount - $ - - U.S. Government securities........ $ 35,118 U.S. Government sponsored agency securities.................... State and municipal (1)............... Other securities........................... 24,732 47,341 100 Totals....................................... $ 107,291 3.66% $ - 174,404 3.65 190,300 4.99 7.51 2,029 4.25% $ 366,733 Mortgage-backed securities (2) .. $1,663,234 3.84% 6,046 4.82 176,450 4.57 4.51 2,329 4.69% $ 184,825 - 5.11 24,896 5.18 7.70 61,376 5.20% $ 86,272 - 6.98 7.54 7.38% (1) Weighted average yields on tax-exempt securities have been computed on a fully tax-equivalent basis assuming a tax rate of 35 percent. (2) Maturities for mortgage-backed securities are dependent upon the interest rate environment and prepayments on the underlying loans. For the purpose of this table, the entire balance and weighted average rate is shown in one period. The Corporation’s investment portfolio consists mainly of mortgage-backed securities which have stated maturities that may differ from actual maturities due to borrowers’ ability to prepay obligations. Cash flows from such investments are dependent upon the performance of the underlying mortgage loans, and are generally influenced by the level of interest rates. As rates increase, cash flows generally decrease as prepayments on the underlying mortgage loans decrease. As rates decrease, cash flows generally increase as prepayments increase. The Corporation invests primarily in five and seven-year balloon mortgage-backed securities to limit interest rate risk and promote liquidity. 29 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following table presents the approximate contractual maturity and interest rate sensitivity of certain loan types, excluding consumer loans and leases, subject to changes in interest rates as of December 31, 2005: One Year or Less One Through Five Years More Than Five Years Total (in thousands) Commercial, financial and agricultural: Floating rate ................................................ $ 491,639 224,145 Fixed rate..................................................... Total ....................................................... $ 715,784 $ 667,365 274,652 $ 942,017 $ $ 645,234 72,634 717,868 $ 1,804,238 571,431 $ 2,375,669 Real-estate – mortgage: Floating rate ................................................ $ 516,839 305,984 Fixed rate..................................................... Total ....................................................... $ 822,823 $ 1,375,377 887,971 $ 2,263,348 $ 1,189,013 330,481 $ 1,519,494 $ 3,081,229 1,524,436 $ 4,605,665 Real-estate – construction: Floating rate ................................................ $ 489,646 66,163 Fixed rate..................................................... Total ....................................................... $ 555,809 $ 140,433 31,601 $ 172,034 $ $ 77,081 46,527 123,608 $ 707,160 144,291 $ 851,451 From a funding standpoint, the Corporation has been able to rely over the years on a stable base of "core" deposits. Even though the Corporation has experienced notable changes in the composition and interest sensitivity of this deposit base, it has been able to rely on this base to provide needed liquidity. In addition, the Corporation issues certificates of deposits in various denominations, including jumbo time deposits, and repurchase agreements as potential sources of liquidity. Contractual maturities of time deposits of $100,000 or more outstanding at December 31, 2005 are as follows (in thousands): Three months or less.................................. $ Over three through six months .................. Over six through twelve months................ Over twelve months................................... Total ..................................................... $ 179,168 153,169 188,586 228,672 749,595 Each of the Corporation's subsidiary banks is a member of the FHLB and has access to FHLB overnight and term credit facilities. At December 31, 2005, the Corporation had $717.0 million in term advances from the FHLB with an additional $1.5 billion of borrowing capacity (including both short-term funding on its lines of credit and long-term borrowings). This availability, along with Federal funds lines at various correspondent banks, provides the Corporation with additional liquidity. 30 3.93% 64,548 4.41% 275,310 7.05% 64,318 275,310 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation The following table provides information about the Corporation’s interest rate sensitive financial instruments. The table presents expected cash flows and weighted average rates for each significant interest rate sensitive financial instrument, by expected maturity period (dollars in thousands). 2006 2007 2008 2009 2010 Beyond Total Expected Maturity Period Estimated Fair Value Fixed rate loans (1).................. $ 756,382 Average rate ........................ Floating rate loans (6) ............. Average rate ........................ 1,524,818 7.41% 6.20% $ 546,456 $ 429,512 $ 310,072 $ 201,492 $ 454,056 $ 2,697,970 $ 2,626,660 6.05% 769,190 7.10% 6.01% 6.19% 6.33% 6.03% 6.12% 588,158 504,913 412,056 1,908,322 5,707,457 5,676,553 7.11% 7.15% 6.77% 6.65% 7.01% Fixed rate investments (2) ....... Average rate ........................ Floating rate investments (2) ... Average rate ........................ 3.82% 3.94% - - 314 4.09% 3.71% 2,319 4.54% 3.71% 157 4.27% 3.83% 588 5.36% 4.80% 61,170 4.40% 530,372 367,649 393,745 327,122 503,492 299,766 2,422,146 2,362,579 Other interest-earning assets.... Average rate ........................ 275,310 7.05% - - - - - - - - - - Total........................................ $ 3,086,882 Average rate........................ 6.46% $ 1,683,609 $ 1,413,734 $ 1,142,264 $1,117,628 $ 2,723,314 $11,167,431 $ 11,005,420 6.07% 5.83% 5.90% 5.36% 6.29% 6.11% Fixed rate deposits (3) ............. $ 1,916,176 Average rate ........................ Floating rate deposits (4)......... Average rate ........................ 1,846,132 3.31% 2.02% Fixed rate borrowings (5) ........ Average rate ........................ Floating rate borrowings ......... Average rate ........................ 623,843 3.14% 939,096 4.37% $ 735,858 3.92% 290,231 0.89% 110,408 4.37% $ 218,553 $ 3.68% 89,483 $ 109,975 $ 274,563 $ 3,344,608 $ 3,321,800 3.95% 4.44% 4.26% 3.60% 240,226 240,226 233,311 2,615,166 5,465,292 5,465,292 0.70% 0.70% 0.66% 0.52% 1.07% 226,243 43,307 89,330 123,198 1,216,329 1,227,413 4.98% 4.77% 5.92% - - - - - - - - 5.23% 1,224 7.66% 4.07% 940,320 4.37% 940,320 Total........................................ $ 5,325,247 Average rate........................ 3.03% $ 1,136,497 $ 685,022 $ 373,016 $ 432,616 $ 3,014,151 3.19% 3.06% 1.95% 2.71% 1.06% $ 10,966,549 2.46% $ 10,954,825 Assumptions: (1) Amounts are based on contractual payments and maturities, adjusted for expected prepayments. (2) Amounts are based on contractual maturities; adjusted for expected prepayments on mortgage-backed securities and expected call on agency and municipal securities. (3) Amounts are based on contractual maturities of time deposits. (4) Money market, Super NOW, NOW and savings accounts are allocated based on history of deposit flows. (5) Amounts are based on contractual maturities of Federal Home Loan Bank advances, adjusted for possible calls. (6) Floating rate loans include adjustable rate commercial mortgages. The preceding table and discussion addressed the liquidity implications of interest rate risk and focused on expected cash flows from financial instruments. Expected maturities, however, do not necessarily reflect the net interest income impact of interest rate changes. Certain financial instruments, such as adjustable rate loans, have repricing periods that differ from expected cash flows. Fair market value adjustments related to acquisitions are not included in the preceding table. In addition to the interest rate sensitive instruments included in the preceding table, the Corporation also had interest rate swaps with a notional amount of $280 million as of December 31, 2005. These swaps were used to hedge certain long-term fixed rate certificates of deposit. The terms of the certificates of deposit and the interest rate swaps mirror each other and were committed to simultaneously. Under the terms of the agreements, the Corporation is the fixed rate receiver and the floating rate payer (generally tied to the three month London Interbank Offering Rate, or LIBOR, a common index used for setting rates between financial institutions). The 31 Fulton Financial Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION combination of the interest rate swaps and the issuance of the certificates of deposit generates long-term floating rate funding for the Corporation. As of December 31, 2005, the Corporation’s weighted average receive and pay rates were 4.19% and 4.34%, respectively. The Corporation entered into a forward-starting interest rate swap with a notional amount of $150 million in October 2005 in anticipation of the January 2006 issuance of trust preferred securities. This was accounted for as a cash flow hedge as it hedges the variability of interest payments attributable to changes in interest rates on the forecasted issuance of fixed-rate debt. The total amount paid in January 2006 as settlement of the forward-starting interest rate swap was $5.5 million. The Corporation uses three complementary methods to measure and manage interest rate risk. They are static gap analysis, simulation of earnings, and estimates of economic value of equity. Static gap provides a measurement of repricing risk in the Corporation’s balance sheet as of a point in time. This measurement is accomplished through stratification of the Corporation’s assets and liabilities into repricing periods. The sum of assets and liabilities in each of these periods are compared for mismatches within that maturity segment. Core deposits having non-contractual maturities are placed into repricing periods based upon historical balance performance. Repricing for mortgage loans and for mortgage-backed securities includes the effect of expected cash flows. Estimated prepayment effects are applied to these balances based upon industry projections for prepayment speeds. The Corporation’s policy limits the cumulative six-month gap to plus or minus 15% of total earning assets. The cumulative six-month gap as of December 31, 2005 was negative 1.18%. The cumulative six-month ratio of rate sensitive assets to rate sensitive liabilities (RSA/RSL) as of December 31, 2005 was 0.97. The following is a summary of the interest sensitivity gaps for six and twelve month intervals as of December 31, 2005: Six Months Twelve Months Cumulative RSA/RSL........... 0.97 0.95 Cumulative GAP (% of earning assets)....................... (1.18)% (2.69)% Simulation of net interest income is performed for the next twelve-month period. A variety of interest rate scenarios are used to measure the effects of sudden and gradual movements upward and downward in the yield curve. These results are compared to the results obtained in a flat or unchanged interest rate scenario. Simulation of earnings is used primarily to measure the Corporation’s short-term earnings exposure to rate movements. The Corporation’s policy limits the potential exposure of net interest income to 10% of the base case net interest income for every 100 basis point “shock” in interest rates. A “shock” is an immediate upward or downward movement of short-term interest rates with changes across the yield curve based upon industry projections. The following table summarizes the expected impact of interest rate shocks on net interest income: Annual change in net interest income + $11.0 million + $7.5 million + $3.9 million - $10.6 million - $21.6 million - $39.1 million Rate Shock +300 bp +200 bp +100 bp -100 bp -200 bp -300 bp % Change +2.6% +1.8% +0.9% -2.6% -5.2% -9.4% Economic value of equity estimates the discounted present value of asset cash flows and liability cash flows. Discount rates are based upon market prices for like assets and liabilities. Upward and downward shocks of interest rates are used to determine the comparative effect of such interest rate movements relative to the unchanged environment. This measurement tool is used primarily to evaluate the longer-term repricing risks and options in the Corporation’s balance sheet. A policy limit of 10% of economic equity may 32 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Fulton Financial Corporation be at risk for every 100 basis point “shock” movement in interest rates. The following table summarizes the expected impact of interest rate shocks on economic value of equity: Change in economic value of equity + $18.5 million + $14.5 million + $7.7 million - $29.3 million - $88.5 million - $174.4 million Rate Shock +300 bp +200 bp +100 bp -100 bp -200 bp -300 bp % Change +1.1% +0.9% +0.5% -1.8% -5.5% -10.8% As with any modeling system, the results of the static gap and simulation of net interest income and economic value of equity are a function of the assumptions and projections built into the model. The actual behavior of the financial instruments could differ from these assumptions and projections. Common Stock As of December 31, 2005, the Corporation had 157.0 million shares of $2.50 par value common stock outstanding held by 51,000 holders of record. The common stock of the Corporation is traded on the national market system of the National Association of Securities Dealers Automated Quotation System (NASDAQ) under the symbol FULT. The following table presents the quarterly high and low prices of the Corporation's common stock and per-share cash dividends declared for each of the quarterly periods in 2005 and 2004. Per-share amounts have been retroactively adjusted to reflect the effect of stock dividends and splits. Price Range High Low Per-Share Dividend 2005 First Quarter ............ $ 18.82 18.00 Second Quarter ........ 18.90 Third Quarter .......... 17.75 Fourth Quarter ........ 2004 First Quarter............... $ 17.36 17.31 Second Quarter .......... 17.52 Third Quarter ............. 18.88 Fourth Quarter ........... $ 16.80 16.46 16.20 15.61 $ 15.89 15.31 16.00 16.84 $ $ 0.132 0.145 0.145 0.145 0.122 0.132 0.132 0.132 33 Fulton Financial Corporation (This page intentionally left blank) 34  Fulton Financial Corporation CONSOLIDATED BALANCE SHEETS (dollars in thousands, except per-share data) Assets Cash and due from banks ................................................................................................................. $ Interest-bearing deposits with other banks ....................................................................................... Federal funds sold ............................................................................................................................. Loans held for sale ............................................................................................................................ Investment securities: Held to maturity (estimated fair value of $18,317 in 2005 and $25,413 in 2004) ...................... Available for sale ......................................................................................................................... Loans, net of unearned income ......................................................................................................... Less: Allowance for loan losses ................................................................................................. Net Loans ................................................................................................................. Premises and equipment ................................................................................................................... Accrued interest receivable .............................................................................................................. Goodwill ........................................................................................................................................... Intangible assets ................................................................................................................................ Other assets ....................................................................................................................................... December 31 2005 368,043 31,404 528 243,378 18,258 2,543,887 8,424,728 (92,847) 8,331,881 170,254 53,261 418,735 29,687 192,239 $ 2004 278,065 4,688 32,000 209,504 25,001 2,424,858 7,533,915 (89,627) 7,444,288 146,911 40,633 364,019 25,303 164,878 Total Assets .............................................................................................................. $ 12,401,555 $ 11,160,148 Liabilities Deposits: Noninterest-bearing ..................................................................................................................... $ 1,672,637 Interest-bearing ............................................................................................................................ 7,132,202 Total Deposits .......................................................................................................... 8,804,839 $ 1,507,799 6,387,725 7,895,524 Short-term borrowings: Federal funds purchased ............................................................................................................... Other short-term borrowings ........................................................................................................ Total Short-Term Borrowings ................................................................................. 939,096 359,866 1,298,962 Accrued interest payable .................................................................................................................. Other liabilities ................................................................................................................................. Federal Home Loan Bank advances and long-term debt................................................................... Total Liabilities ........................................................................................................ 38,604 115,834 860,345 11,118,584 Shareholders' Equity Common stock, $2.50 par value, 600 million shares authorized, 172.3 million shares issued in 2005 and 167.8 million shares issued in 2004.......................................................................... Additional paid-in capital ................................................................................................................. Retained earnings ............................................................................................................................. Accumulated other comprehensive loss ............................................................................................ Treasury stock (15.3 million shares in 2005 and 10.7 million shares in 2004), at cost .................... Total Shareholders' Equity ...................................................................................... 430,827 996,708 138,529 (42,285) (240,808) 1,282,971 676,922 517,602 1,194,524 27,279 114,498 684,236 9,916,061 335,604 1,018,403 60,924 (10,133) (160,711) 1,244,087 Total Liabilities and Shareholders' Equity .............................................................. $ 12,401,555 $ 11,160,148 See Notes to Consolidated Financial Statements 35 Fulton Financial Corporation CONSOLIDATED STATEMENTS OF INCOME (dollars in thousands, except per-share data) Interest Income Loans, including fees ..................................................................................... $ Investment securities: Taxable ..................................................................................................... Tax-exempt ............................................................................................... Dividends .................................................................................................. Loans held for sale ........................................................................................ Other interest income .................................................................................... Total Interest Income ........................................................... Interest Expense Deposits ......................................................................................................... Short-term borrowings ................................................................................... Long-term debt .............................................................................................. Total Interest Expense .......................................................... Net Interest Income .............................................................. Provision for Loan Losses ........................................................................... Net Interest Income After 75,150 12,114 4,564 14,940 1,586 625,797 140,774 34,414 38,031 213,219 412,578 3,120 Provision for Loan Losses ............................................. 409,458 Other Income Investment management and trust services .................................................... Service charges on deposit accounts ............................................................. Other service charges and fees ...................................................................... Gain on sale of mortgage loans ...................................................................... Investment securities gains ............................................................................ Other .............................................................................................................. Total Other Income ............................................................... Other Expenses Salaries and employee benefits ..................................................................... Net occupancy expense ................................................................................. Equipment expense ........................................................................................ Data processing ............................................................................................. Advertising ..................................................................................................... Intangible amortization................................................................................... Other .............................................................................................................. Total Other Expenses ........................................................... Income Before Income Taxes ............................................... Income Taxes ............................................................................................... 35,669 40,198 24,200 25,468 6,625 12,108 144,268 181,889 29,275 11,938 12,395 8,823 5,311 66,660 316,291 237,435 71,361 2005 Year Ended December 31 2004 2003 517,443 $ 394,765 $ 340,375 76,792 9,553 4,023 8,407 103 493,643 89,779 15,182 31,033 135,994 357,649 4,717 352,932 34,817 39,451 20,494 19,262 17,712 7,128 138,864 166,026 23,813 10,769 11,430 6,943 4,726 53,808 277,515 214,281 64,673 77,450 10,436 4,076 2,953 241 435,531 94,198 7,373 29,523 131,094 304,437 9,705 294,732 33,898 38,500 18,860 18,965 19,853 4,294 134,370 138,094 19,896 10,505 11,532 6,039 2,059 45,526 233,651 195,451 59,084 Net Income ............................................................................ $ 166,074 $ 149,608 $ 136,367 Per-Share Data: Net Income (Basic)......................................................................................... $ Net Income (Diluted)...................................................................................... Cash Dividends............................................................................................... 1.06 1.05 0.567 $ 1.00 0.99 0.518 $ 0.97 0.96 0.475 See Notes to Consolidated Financial Statements 36  Fulton Financial Corporation CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME Number of Shares Outstanding Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Income (Loss) Treasury Stock Total (dollars in thousands) Balance at January 1, 2003 ...................................................... 139,338,000 $ 259,943 $ 493,538 $ 127,128 $ 34,801 $ (50,531) $ 864,879 Comprehensive Income: Net Income................................................................ Unrealized loss on securities (net of $5.2 million tax effect).............................. Less - reclassification adjustment for gains included in net income (net of $6.9 million tax expense)..................................... Total comprehensive income............................... Stock dividend - 5%.......................................................... Stock issued, including related tax benefits........................ Stock-based compensation awards..................................... Stock issued for acquisition of Premier Bancorp, Inc.................................................. Acquisition of treasury stock............................................. Cash dividends - $0.475 per share...................................... 136,367 (9,630) (12,904) 707,000 6,058,000 (4,018,000) 12,998 (92,526) 79,491 (3,605) 2,092 11,539 76,639 (66,782) 9,458 (59,699) 136,367 (9,630) (12,904) 113,833 (37) 5,853 2,092 88,178 (59,699) (66,782) Balance at December 31, 2003................................................. 142,085,000 $ 284,480 $ 648,155 $ 104,187 $ 12,267 $ (100,772) $ 948,317 Comprehensive Income: Net Income................................................................ Unrealized loss on securities (net of $5.6 million tax effect).............................. Less - reclassification adjustment for gains included in net income (net of $6.2 million tax expense)..................................... Minimum pension liability adjustment (net of $300,000 tax effect)................................. Total comprehensive income............................... Stock dividend - 5%.......................................................... Stock issued, including related tax benefits........................ Stock-based compensation awards..................................... Stock issued for acquisition of 149,608 (10,329) (11,513) (558) 1,310,000 15,278 (115,615) 100,247 (9,141) 3,900 Resource Bankshares Corporation.............................. 11,287,000 21,498 164,365 Stock issued for acquisition of First Washington FinancialCorp.................................. Acquisition of treasury stock............................................. Cash dividends - $0.518 per share...................................... 7,174,000 (4,706,000) 14,348 110,877 (77,256) 149,608 (10,329) (11,513) (558) 127,208 (90) 9,886 3,900 185,863 125,225 (78,966) (77,256) 19,027 (78,966) Balance at December 31, 2004................................................. 157,150,000 $ 335,604 $ 1,018,403 $ 60,924 $ (10,133) $ (160,711) $ 1,244,087 Comprehensive Income: Net Income................................................................ Unrealized loss on securities (net of $14.1 million tax effect)............................ Unrealized loss on derivative financial instruments (net of $1.2 million tax effect).................................................................. Less - reclassification adjustment for gains included in net income (net of $2.3 million tax expense)..................................... Minimum pension liability adjustment (net of $300,000 tax effect)................................. Total comprehensive income......................... 5-for-4 stock split paid in the form of a 25 % stock dividend............................................ Stock issued, including related tax benefits........................ Stock-based compensation awards..................................... Stock issued for acquisition of SVB Financial Services, Inc........................................ Acquisition of treasury stock............................................. Cash dividends - $0.567 per share...................................... (26,219) (2,185) (4,306) 558 166,074 (88,469) 5,071 (85,168) 166,074 (26,219) (2,185) (4,306) 558 133,922 (68) 11,059 1,041 66,567 (85,168) (88,469) 1,120,000 3,747,000 (5,000,000) 84,046 1,809 (84,114) 4,179 1,041 9,368 57,199 Balance at December 31, 2005................................................. 157,017,000 $ 430,827 $ 996,708 $ 138,529 $ (42,285) $ (240,808) $ 1,282,971 See Notes to Consolidated Financial Statements 37 Fulton Financial Corporation CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net Income ................................................................................................................... $ 166,074 $ 149,608 $ 136,367 Year Ended December 31 2004 2005 2003 Adjustments to reconcile net income to net cash provided by Operating Activities: Provision for loan losses ........................................................................................ Depreciation and amortization of premises and equipment ................................... Net amortization of investment security premiums ................................................ Deferred income tax expense.................................................................................. Gain on sale of investment securities...................................................................... Gain on sale of loans............................................................................................... Proceeds from sales of loans held for sale.............................................................. Originations of loans held for sale.......................................................................... Amortization of intangible assets .......................................................................... Stock-based compensation expense........................................................................ (Increase) decrease in accrued interest receivable .................................................. (Increase) decrease in other assets ......................................................................... Increase (decrease) in accrued interest payable ...................................................... (Decrease) increase in other liabilities ................................................................... Total adjustments ............................................................................................ Net cash provided by operating activities ...................................................... CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of securities available for sale ............................................... Proceeds from maturities of securities held to maturity ......................................... Proceeds from maturities of securities available for sale ....................................... Purchase of securities held to maturity .................................................................. Purchase of securities available for sale ................................................................. Decrease (increase) in short-term investments ....................................................... Net increase in loans .............................................................................................. Net cash (paid for) received from acquisitions ...................................................... Net purchase of premises and equipment ............................................................... Net cash (used in) provided by investing activities ........................................ CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in demand and savings deposits ........................................................ Net increase (decrease) in time deposits ................................................................ Addition to long-term debt .................................................................................... Repayment of long-term debt ................................................................................. Decrease (increase) in short-term borrowings ........................................................ Dividends paid ....................................................................................................... Net proceeds from issuance of common stock ....................................................... Acquisition of treasury stock ................................................................................. Net cash provided by (used in) financing activities ........................................ 3,120 14,338 5,158 990 (6,625) (25,468) 2,307,004 (2,315,410) 5,311 1,041 (10,501) (1,530) 11,008 (8,019) (19,583) 146,491 143,806 10,846 666,060 (4,403) (861,897) 78,265 (589,053) (3,791) (28,336) (588,503) 35,153 400,672 319,606 (168,207) 104,438 (85,495) 10,991 (85,168) 531,990 4,717 12,409 9,906 816 (17,712) (19,262) 1,475,000 (1,456,465) 4,726 3,900 22 6,895 (759) 3,089 27,282 176,890 235,332 8,870 816,834 (11,402) (269,776) (9,188) (577,403) 7,810 (16,161) 184,916 293,331 (174,453) 45,000 (63,509) (338,845) (74,802) 7,537 (78,966) (384,707) 9,705 12,379 19,243 4,465 (19,853) (18,965) 871,447 (815,291) 2,059 2,092 11,333 (14,595) (6,136) (7,370) 50,513 186,880 521,520 18,146 1,543,992 (8,514) (2,445,592) 19,248 (485,332) 17,222 (4,730) (824,040) 347,665 (295,760) 90,000 (157,360) 757,964 (64,628) 5,087 (59,699) 623,269 Net Increase (Decrease) in Cash and Due From Banks ............................................ Cash and Due From Banks at Beginning of Year ..................................................... Cash and Due From Banks at End of Year ............................................................... 89,978 278,065 368,043 $ (22,901) 300,966 278,065 $ (13,891) 314,857 300,966 $ Supplemental Disclosures of Cash Flow Information Cash paid during the year for: Interest ................................................................................................................... Income taxes .......................................................................................................... $ 202,211 60,539 $ 136,753 54,457 $ 137,230 48,924 See Notes to Consolidated Financial Statements 38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fulton Financial Corporation NOTE A – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business: Fulton Financial Corporation (Parent Company) is a multi-bank financial holding company which provides a full range of banking and financial services to businesses and consumers through its wholly owned banking subsidiaries: Fulton Bank, Lebanon Valley Farmers Bank, Swineford National Bank, Lafayette Ambassador Bank, FNB Bank N.A., Hagerstown Trust, Delaware National Bank, The Bank, The Peoples Bank of Elkton, Skylands Community Bank, Premier Bank, Resource Bank, First Washington State Bank and Somerset Valley Bank as well as its financial services subsidiaries: Fulton Financial Advisors, N.A., and Fulton Insurance Services Group, Inc. In addition, the Parent Company owns the following other non-bank subsidiaries: Fulton Financial Realty Company, Fulton Reinsurance Company, LTD, Central Pennsylvania Financial Corp., FFC Management, Inc. and FFC Penn Square, Inc. Collectively, the Parent Company and its subsidiaries are referred to as the Corporation. The Corporation's primary sources of revenue are interest income on loans and investment securities and fee income on its products and services. Its expenses consist of interest expense on deposits and borrowed funds, provision for loan losses, other operating expenses and income taxes. The Corporation’s primary competition is other financial services providers operating in its region. Competitors also include financial services providers located outside the Corporation’s geographical market as a result of the growth in electronic delivery systems. The Corporation is subject to the regulations of certain Federal and state agencies and undergoes periodic examinations by such regulatory authorities. The Corporation offers, through its banking subsidiaries, a full range of retail and commercial banking services throughout central and eastern Pennsylvania, Maryland, Delaware, New Jersey and Virginia. Industry diversity is the key to the economic well being of these markets and the Corporation is not dependent upon any single customer or industry. Basis of Financial Statement Presentation: The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States and include the accounts of the Parent Company and all wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements as well as revenues and expenses during the period. Actual results could differ from those estimates. Investments: Debt securities are classified as held to maturity at the time of purchase when the Corporation has both the intent and ability to hold these investments until they mature. Such debt securities are carried at cost, adjusted for amortization of premiums and accretion of discounts using the effective yield method. The Corporation does not engage in trading activities, however, since the investment portfolio serves as a source of liquidity, most debt securities and all marketable equity securities are classified as available for sale. Securities available for sale are carried at estimated fair value with the related unrealized holding gains and losses reported in shareholders' equity as a component of other comprehensive income, net of tax. Realized security gains and losses are computed using the specific identification method and are recorded on a trade date basis. Securities are evaluated periodically to determine whether a decline in their value is other than temporary. Declines in value that are determined to be other than temporary are recorded as realized losses. Loans and Revenue Recognition: Loan and lease financing receivables are stated at their principal amount outstanding, except for loans held for sale which are carried at the lower of aggregate cost or market value. Interest income on loans is accrued as earned. Unearned income on lease financing receivables is recognized on a basis which approximates the effective yield method. Premiums and discounts on purchased loans are amortized as an adjustment to interest income using the effective yield method. Accrual of interest income is generally discontinued when a loan becomes 90 days past due as to principal or interest, except for adequately collateralized residential mortgage loans. When interest accruals are discontinued, unpaid interest credited to income is reversed. Non-accrual loans are restored to accrual status when all delinquent principal and interest become current or the loan is considered secured and in the process of collection. Derivative Financial Instruments: As of December 31, 2005, interest rate swaps with a notional amount of $280 million were used to hedge certain long-term fixed rate certificates of deposit. The terms of the certificates of deposit and the interest rate swaps mirror 39 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS each other and were committed to simultaneously. Under the terms of the swap agreements, the Corporation is the fixed rate receiver and the floating rate payer (generally tied to the three month London Interbank Offering Rate, or LIBOR, a common index used for setting rates between financial institutions). The interest rate swaps are classified as fair value hedges and both the interest rate swaps and the certificates of deposit are recorded at fair value. Changes in the fair values during the period are recorded in interest expense. For interest rate swaps accounted for as a fair value hedge, ineffectiveness is the difference between the changes in the fair value of the interest rate swap and the hedged item, in this case certificates of deposit. The Corporation’s analysis of hedge effectiveness indicated they were 97.1% effective as of December 31, 2005. As a result, a $110,000 charge to expense was recorded for the year ended December 31, 2005, compared to a $14,000 favorable adjustment to income for the year ended December 31, 2004. The Corporation entered into a forward-starting interest rate swap with a notional amount of $150 million in October 2005 in anticipation of the issuance of $150 million of trust preferred securities in January 2006. This was accounted for as a cash flow hedge as it hedges the variability of interest payments attributable to changes in interest rates on the forecasted issuance of fixed-rate debt. The Corporation’s analysis indicated the hedge was effective as of December 31, 2005. Therefore, during the year ended December 31, 2005, the Corporation recorded a $2.2 million other comprehensive loss (net of $1.2 million tax effect) to recognize the fair value change of this derivative. The Corporation settled this derivative in January 2006 for a total of $5.5 million. The total amount recorded to other comprehensive loss will be amortized to interest expense over the life of the related securities using the effective interest method. The total amount of net losses in accumulated other comprehensive income that will be reclassified into earnings in 2006 is expected to be approximately $170,000. Loan Origination Fees and Costs: Loan origination fees and the related direct origination costs are offset and the net amount is deferred and amortized over the life of the loan using the effective interest method as an adjustment to interest income. For mortgage loans sold, the net amount is included in gain or loss upon the sale of the related mortgage loan. Allowance for Loan Losses: The allowance for loan losses is increased by charges to expense and decreased by charge-offs, net of recoveries. Management's periodic evaluation of the adequacy of the allowance for loan losses is based on the Corporation's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrowers' ability to repay, the estimated fair value of the underlying collateral, and current economic conditions. Management believes that the allowance for loan losses is adequate, however, future changes to the allowance may be necessary based on changes in any of these factors. The allowance for loan losses consists of two components – specific allowances allocated to individually impaired loans, as defined by the Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan” (Statement 114), and allowances calculated for pools of loans under Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (Statement 5). Commercial loans and commercial mortgages are reviewed for impairment under Statement 114 if they are both greater than $100,000 and are rated less than “satisfactory” based upon the Corporation’s internal credit-rating process. A satisfactory loan does not present more than a normal credit risk based on the strength of the borrower’s management, financial condition and trends, and the type and sufficiency of underlying collateral. It is expected that the borrower will be able to satisfy the terms of the loan agreement. A loan is considered to be impaired when, based on current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or at the loan's observable market price or fair value of the collateral if the loan is collateral dependent. An allowance is allocated to an impaired loan if the carrying value exceeds the calculated estimated fair value. All loans not reviewed for impairment are evaluated under Statement 5. In addition to commercial loans and mortgages not meeting the impairment evaluation criteria discussed above, these include residential mortgages, consumer loans, installment loans and lease receivables. These loans are segmented into groups with similar characteristics and an allowance for loan losses is allocated to each segment based on quantitative factors such as recent loss history and qualitative factors such as economic conditions and trends. Loans and lease financing receivables deemed to be a loss are written off through a charge against the allowance for loan losses. Consumer loans are generally charged off when they become 120 days past due if they are not adequately secured by real estate. All other loans are evaluated for possible charge-off when they reach 90 days past due. Such loans or portions thereof are charged-off 40  Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS when it is probable that the balance will not be collected, based on the ability of the borrower to pay and the value of the underlying collateral. Recoveries of loans previously charged off are recorded as an increase to the allowance for loan losses. Past due status is determined based on contractual due dates for loan payments. Lease financing receivables include both open and closed end leases for the purchase of vehicles and equipment. Residual values are set at the inception of the lease and are reviewed periodically for impairment. If the impairment is considered to be other-than- temporary, the resulting reduction in the net investment in the lease is recognized as a loss in the period. Premises and Equipment: Premises and equipment are stated at cost, less accumulated depreciation and amortization. The provision for depreciation and amortization is generally computed using the straight-line method over the estimated useful lives of the related assets, which are a maximum of 50 years for buildings and improvements and eight years for furniture and equipment. Leasehold improvements are amortized over the shorter of 15 years or the noncancelable lease term. Interest costs incurred during the construction of major bank premises are capitalized. Other Real Estate Owned: Assets acquired in settlement of mortgage loan indebtedness are recorded as other real estate owned and are included in other assets initially at the lower of the estimated fair value of the asset less estimated selling costs or the carrying amount of the loan. Costs to maintain the assets and subsequent gains and losses on sales are included in other income and other expense. Mortgage Servicing Rights: The estimated fair value of mortgage servicing rights (MSR’s) related to loans sold is recorded as an asset upon the sale of such loans. MSR’s are amortized as a reduction to servicing income over the estimated lives of the underlying loans. In addition, MSR’s are evaluated quarterly for impairment based on prepayment experience and, if necessary, additional amortization is recorded. Income Taxes: The provision for income taxes is based upon income before income taxes, adjusted primarily for the effect of tax- exempt income and net credits received from investments in low income housing partnerships. Certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the applicable enacted marginal tax rate. Deferred income tax expenses or benefits are based on the changes in the deferred tax asset or liability from period to period. Stock-Based Compensation: The Corporation accounts for its stock-based compensation awards in accordance with Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (Statement 123R). Statement 123R requires public companies to recognize compensation expense related to stock-based compensation awards in their income statements. Net Income Per Share: The Corporation’s basic net income per share is calculated as net income divided by the weighted average number of shares outstanding. For diluted net income per share, net income is divided by the weighted average number of shares outstanding plus the incremental number of shares added as a result of converting common stock equivalents, calculated using the treasury stock method. The Corporation’s common stock equivalents consist of outstanding stock options. Excluded from the calculation were anti-dilutive options totaling 1.1 million in 2005. A reconciliation of the weighted average shares outstanding used to calculate basic net income per share and diluted net income per share follows. There were no adjustments to net income to arrive at diluted net income per share. Weighted average shares outstanding (basic) ............................. Impact of common stock equivalents .......................................... Weighted average shares outstanding (diluted)........................... 156,413 1,930 158,343 149,294 1,614 150,908 140,335 1,176 141,511 2005 2004 (in thousands) 2003 41 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Disclosures about Segments of an Enterprise and Related Information: The Corporation does not have any operating segments which require disclosure of additional information. While the Corporation owns fourteen separate banks, each engages in similar activities, provides similar products and services, and operates in the same general geographical area. The Corporation’s non-banking activities are immaterial and, therefore, separate information has not been disclosed. Financial Guarantees: Financial guarantees, which consist primarily of standby and commercial letters of credit, are accounted for by recognizing a liability equal to the fair value of the guarantees and crediting the liability to income over the term of the guarantee. Fair value is estimated using the fees currently charged to enter into similar agreements with similar terms. Business Combinations and Intangible Assets: The Corporation accounts for its acquisitions using the purchase accounting method as required by Statement of Financial Accounting Standards No. 141, “Business Combinations”. Purchase accounting requires the total purchase price to be allocated to the estimated fair values of assets and liabilities acquired, including certain intangible assets that must be recognized. Typically, this results in a residual amount in excess of the net fair values, which is recorded as goodwill. As required by Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (Statement 142), goodwill is not amortized to expense, but is tested for impairment at least annually. Write-downs of the balance, if necessary as a result of the impairment test, are to be charged to the results of operations in the period in which the impairment is determined. The Corporation performed its annual tests of goodwill impairment on October 31 of each year. Based on the results of these tests the Corporation concluded that there was no impairment and no write-downs were recorded. If certain events occur which might indicate goodwill has been impaired, the goodwill is tested when such events occur. As required by Statement of Financial Accounting Standards No. 147, “Acquisitions of Certain Financial Institutions” (Statement 147) the excess purchase price recorded in qualifying branch acquisitions are treated in the same manner as Statement 142 goodwill. Variable Interest Entities: FASB Interpretation No. 46, “Consolidation of Variable Interest Entities – An Interpretation of ARB No. 51” (FIN 46), provides guidance on when to consolidate certain Variable Interest Entities (VIE’s) in the financial statements of the Corporation. VIE’s are entities in which equity investors do not have a controlling financial interest or do not have sufficient equity at risk for the entity to finance activities without additional financial support from other parties. Under FIN 46, a company must consolidate a VIE if the company has a variable interest that will absorb a majority of the VIE’s losses, if they occur, and/or receive a majority of the VIE’s residual returns, if they occur. For the Corporation, FIN 46 affects corporation-obligated mandatorily redeemable capital securities issued by subsidiary trusts (Subsidiary Trusts) and its investments in low and moderate-income housing partnerships (LIH investments). The provisions of FIN 46 related to Subsidiary Trusts, as interpreted by the Securities and Exchange Commission, disallow consolidation of Subsidiary Trusts in the financial statements of the Corporation. As a result, securities that were issued by the trusts (Trust Preferred Securities) are not included in the Corporation’s consolidated balance sheets. The junior subordinated debentures issued by the Parent Company to the Subsidiary Trusts remain in long-term debt (See Note I, “Short Term Borrowings and Long- Term Debt”). The adoption of FIN 46 with respect to Subsidiary Trusts had no impact on net income or net income per share as the terms of the junior subordinated debentures mirror the terms of the Trust Preferred Securities. Current regulatory capital rules allow Trust Preferred Securities to be included as a component of regulatory capital. This treatment has continued despite the adoption of FIN 46. If banking regulators make a determination that Trust Preferred Securities can no longer be considered in regulatory capital, the securities become callable and the Corporation may redeem them. LIH Investments are amortized under the effective interest method over the life of the Federal income tax credits generated as a result of such investments, generally ten years. At December 31, 2005 and 2004, the Corporation’s LIH Investments totaled $44.2 million and $52.0 million, respectively. The net income tax benefit associated with these investments was $4.9 million, $4.5 million, and $4.0 million in 2005, 2004 and 2003, respectively. None of the Corporation’s LIH Investments met the consolidation criteria of FIN 46 as of December 31, 2005 or 2004. Accounting for Certain Loans or Debt Securities Acquired in a Transfer: In December 2003, the Accounting Standards Executive Committee issued Statement of Position 03-3 (SOP 03-3), “Accounting for Certain Loans or Debt Securities Acquired in a 42  Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Transfer”. SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer, including business combinations, if those differences are attributable, at least in part, to credit quality. SOP 03-3 became effective for the Corporation on January 1, 2005 and was applicable to the July 2005 acquisition of SVB Financial Services, Inc. Few of the loans acquired in this transaction met the scope of SOP 03-3 and, as such, there was no material impact on the consolidated financial statements. Other-Than-Temporary Impairment: In 2004, the Emerging Issues Task Force (EITF) released EITF Issue 03-01, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments” (EITF 03-01), which provides guidance for evaluating whether an investment is other-than-temporarily impaired and requires certain disclosures with respect to these investments. In June 2005, the FASB voted to nullify certain provisions of EITF 03-1 which addressed the evaluation of an impairment to determine whether it was other-than-temporary. In general, these provisions required companies to declare their ability and intent to hold other-than-temporarily impaired investments until they recovered their losses. If a company were unable to make this declaration, write-downs of investment securities through losses charged to the income statement would be required. The effective date of these provisions was originally delayed in September 2004, due to industry concerns about the potential impact of this proposed accounting. Adoption of the surviving provisions of EITF 03-1 did not have a material impact on the Corporation’s financial condition or results of operations. The Corporation continues to apply the provisions of existing authoritative literature in evaluating its investments for other-than-temporary impairment. Loan Products That May Give Rise to a Concentration of Credit Risk: In December 2005, the FASB issued Staff Position No. SOP 94-6-1, “Terms of Loan Products That May Give Rise to a Concentration of Credit Risk” (SOP 94-6-1), which requires separate fair value disclosures for loan products that increase an entity’s exposure to credit risk. Loan products that result in an increased exposure risk include, but are not limited to, products with characteristics such as: borrowers subject to significant payment increases, loans with terms that permit negative amortization, or loans with high loan-to-value ratios. SOP 94-6-1 became effective for the Corporation on December 31, 2005, and did not have a material impact on the Corporation’s consolidated financial statements. Reclassifications and Restatements: Certain amounts in the 2004 and 2003 consolidated financial statements and notes have been reclassified to conform to the 2005 presentation. All share and per-share data have been restated to reflect the impact of the 5-for-4 stock split paid in the form of a 25% stock dividend in June 2005. As a result of adopting Statement 123R in 2005 using the “modified retrospective application”, prior period financial information has been restated. See Note M, “Stock-Based Compensation Plans and Shareholders’ Equity” for more information. NOTE B – RESTRICTIONS ON CASH AND DUE FROM BANKS The Corporation's subsidiary banks are required to maintain reserves, in the form of cash and balances with the Federal Reserve Bank, against their deposit liabilities. The average amount of such reserves during 2005 and 2004 was approximately $106.9 million and $100.8 million, respectively. 43 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE C – INVESTMENT SECURITIES The following tables present the amortized cost and estimated fair values of investment securities as of December 31: 2005 Held to Maturity Amortized Cost Gross Gross Unrealized Unrealized Gains Losses Estimated Fair Value (in thousands) U.S. Government sponsored agency securities ............................ $ State and municipal securities ............. Mortgage-backed securities ................ $ 7,512 5,877 4,869 18,258 2005 Available for Sale 137,462 35,124 Equity securities .................................. $ U.S. Government securities................. U.S. Government sponsored agency securities ............................ 206,340 State and municipal securities ............. 444,034 Corporate debt securities..................... 64,478 Mortgage-backed securities ................ 1,718,237 $ 2,605,675 $ $ $ $ - $ 19 143 162 $ (103) $ - - (103) $ 7,409 5,896 5,012 18,317 2,029 $ - (3,959) $ (6) 135,532 35,118 92 1,044 1,860 928 5,953 $ 205,182 (1,250) 438,987 (6,091) 65,834 (504) 1,663,234 (55,931) (67,741) $ 2,543,887 2004 Held to Maturity U.S. Government sponsored agency securities ............................ $ State and municipal securities ............. Corporate debt securities..................... Mortgage-backed securities ................ $ 2004 Available for Sale Equity securities ................................. $ U.S. Government securities ................ U.S. Government sponsored agency securities............................ State and municipal securities ............ Corporate debt securities .................... Mortgage-backed securities ................ 6,903 10,658 650 6,790 25,001 $ $ 78 65 1 323 467 $ (55) $ - - - $ (55) $ 6,926 10,723 651 7,113 25,413 163,249 $ 68,497 7,822 - $ (1,006) $ 170,065 68,449 (48) 60,332 328,726 68,215 1,750,080 $ 2,439,099 $ 144 4,350 3,053 1,427 16,796 - 60,476 (621) 332,455 (141) 71,127 1,722,286 (29,221) (31,037) $ 2,424,858 $ 44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The amortized cost and estimated fair value of debt securities at December 31, 2005, by contractual maturity, are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Fulton Financial Corporation Held to Maturity Available for Sale Amortized Cost Estimated Fair Value Amortized Cost Estimated Fair Value (in thousands) Due in one year or less........................... $ Due from one year to five years............. Due from five years to ten years ............ Due after ten years ................................. Mortgage-backed securities ................... $ 4,540 8,503 346 - 13,389 4,869 18,258 $ $ 4,540 8,419 346 - 13,305 5,012 18,317 $ 107,387 371,204 186,879 84,506 749,976 1,718,237 $2,468,213 $ 107,291 366,733 184,825 86,272 745,121 1,663,234 $2,408,355 Gross gains totaling $5.9 million, $14.8 million and $17.5 million were realized on the sale of equity securities during 2005, 2004 and 2003, respectively. Gross losses, including losses recognized for other-than-temporary impairment as discussed below, totaling $68,000, $149,000 and $3.5 million were realized during 2005, 2004 and 2003, respectively. Gross gains totaling $1.6 million, $3.1 million and $5.9 million were realized on the sale of available for sale debt securities during 2005, 2004 and 2003, respectively. Gross losses totaling $811,000 were realized on the sale of available for sale debt securities during 2005. Securities carried at $1.3 billion and $1.2 billion at December 31, 2005 and 2004, respectively, were pledged as collateral to secure public and trust deposits and customer and brokered repurchase agreements. The following table presents the gross unrealized losses and estimated fair values of investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005: Less Than 12 months Estimated Unrealized Fair Value Losses 12 Months or Longer Total Estimated Fair Value Unrealized Losses Estimated Fair Value Unrealized Losses (in thousands) U.S. Government securities ................................ $ 32,659 172,338 U.S. Government sponsored agency securities... 275,519 State and municipal securities............................. Corporate debt securities .................................... 17,083 376,984 Mortgage-backed securities ................................ 874,583 Total debt securities ....................................... Equity securities.................................................. 39,753 Total............................................................... $ 914,336 $ (6) (1,250) (4,012) (335) (6,681) (12,284) (3,281) $ (15,565) $ - 7,409 61,469 7,480 1,148,968 1,225,326 7,544 $ 1,232,870 $ $ - (103) (2,079) (169) (49,250) (51,601) (678) 32,659 179,747 336,988 24,563 1,525,952 2,099,909 47,297 $ (52,279) $ 2,147,206 $ (6) (1,353) (6,091) (504) (55,931) (63,885) (3,959) $ (67,844) Mortgage-backed securities primarily consist of five and seven-year balloon pools issued by the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal National Mortgage Association (FNMA) as well as sequential collateralized mortgage obligations also issued by FHLMC and FNMA. The majority of the securities shown in the above table were purchased during 2003 and 2004 when mortgage rates were at historical lows. Unrealized losses on these securities at December 31, 2005 resulted from the substantial increase in market rates over the past 18 months. Because FHLMC and FNMA guarantee the timely payment of principal, the credit risk for these securities is minimal and, as such, no impairment write-offs were considered to be necessary. For similar reasons, the Corporation does not consider unrealized losses associated with U.S. government sponsored equity securities or state and municipal securities as an indication of impairment. 45 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Corporation evaluates whether unrealized losses on equity investments indicate other than temporary impairment. Based upon this evaluation, losses of $65,000, $137,000 and $3.3 million were recognized in 2005, 2004 and 2003, respectively. NOTE D – LOANS AND ALLOWANCE FOR LOAN LOSSES Gross loans are summarized as follows as of December 31: 2005 2004 (in thousands) Commercial - industrial and financial .................................................... $ 2,044,010 Commercial - agricultural....................................................................... 331,659 Real-estate - commercial mortgage ........................................................ 2,831,405 Real-estate - residential mortgage and home equity............................... 1,774,260 Real-estate - construction ....................................................................... 851,451 Consumer ............................................................................................... 519,094 Leasing and other ................................................................................... 79,738 8,431,617 (6,889) $ 8,424,728 Unearned income.................................................................................... $ 1,946,962 326,176 2,461,016 1,651,321 595,567 486,877 72,795 7,540,714 (6,799) $ 7,533,915 Changes in the allowance for loan losses were as follows for the years ended December 31: 2005 2004 (in thousands) 2003 Balance at beginning of year ........................................ $ 89,627 $ 77,700 $ 71,920 Loans charged off......................................................... Recoveries of loans previously charged off ................. Net loans charged off .............................................. Provision for loan losses .............................................. Allowance purchased ................................................... (8,204) 5,196 (3,008) 3,120 3,108 (8,877) 4,520 (4,357) 4,717 11,567 (13,228) 3,829 (9,399) 9,705 5,474 Balance at end of year ................................................. $ 92,847 $ 89,627 $ 77,700 The following table presents non-performing assets as of December 31: Non-accrual loans................................................................................... $ Accruing loans greater than 90 days past due ........................................ Other real estate owned .......................................................................... $ 36,560 9,012 2,072 47,644 $ $ 22,574 8,318 2,209 33,101 2005 2004 (in thousands) Interest of approximately $3.0 million, $1.5 million and $1.8 million was not recognized as interest income due to the non-accrual status of loans during 2005, 2004 and 2003, respectively. 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fulton Financial Corporation The recorded investment in loans that were considered to be impaired as defined by Statement 114 was $145.5 million and $130.6 million at December 31, 2005 and 2004, respectively. At December 31, 2005 and 2004, $13.2 million and $6.6 million of impaired loans were included in non-accrual loans, respectively. At December 31, 2005 and 2004, impaired loans had related allowances for loan losses of $49.5 million and $41.6 million, respectively. There were no impaired loans in 2005 and 2004 that did not have a related allowance for loan losses. The average recorded investment in impaired loans during the years ended December 31, 2005, 2004 and 2003 was approximately $128.1 million, $108.0 million, and $78.4 million, respectively. The Corporation applies all payments received on non-accruing impaired loans to principal until such time as the principal is paid off, after which time any additional payments received are recognized as interest income. Payments received on accruing impaired loans are applied to principal and interest according to the original terms of the loan. The Corporation recognized interest income of approximately $7.7 million, $5.6 million and $3.9 million on impaired loans in 2005, 2004 and 2003, respectively. The Corporation has extended credit to the officers and directors of the Corporation and to their associates. Related-party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectibility. The aggregate dollar amount of these loans, including unadvanced commitments, was $267.2 million and $209.8 million at December 31, 2005 and 2004, respectively. During 2005, additions totaled $74.5 million and repayments totaled $18.4 million. Somerset Valley Bank added $1.3 million to related party loans. The total portfolio of mortgage loans serviced by the Corporation for unrelated third parties was $1.2 billion and $1.1 billion at December 31, 2005 and 2004, respectively. NOTE E – PREMISES AND EQUIPMENT The following is a summary of premises and equipment as of December 31: 2005 2004 (in thousands) Land........................................................................................................ $ Buildings and improvements.................................................................. Furniture and equipment ........................................................................ Construction in progress......................................................................... Less: Accumulated depreciation and amortization................................. 26,693 180,153 119,179 5,483 331,508 (161,254) $ 170,254 $ 25,253 149,700 105,406 10,967 291,326 (144,415) $ 146,911 NOTE F – GOODWILL AND INTANGIBLE ASSETS The following table summarizes the changes in goodwill: 2005 2004 (in thousands) 2003 Balance at beginning of year ........................................ $ 364,019 Goodwill additions ....................................................... 54,716 Balance at end of year .................................................. $ 418,735 $ 127,202 236,817 $ 364,019 $ 61,048 66,154 $ 127,202 See Note Q, “Mergers and Acquisitions” for information regarding goodwill acquired in 2005 and 2004. 47 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes intangible assets at December 31: 2005 Accumulated Amortization Gross Net Gross (in thousands) 2004 Accumulated Amortization Amortizing: Core deposit ........................... $ Non-compete.......................... Unidentifiable ........................ Total amortizing.................. Non-amortizing - Trade name... $ 35,824 475 8,875 45,174 1,280 46,454 $ $ (11,448) (135) (5,184) (16,767) - $ (16,767) $ 24,376 340 3,691 28,407 1,280 29,687 $ $ 27,678 475 7,706 35,859 900 36,759 $ $ (7,418) (40) (3,998) (11,456) - $ (11,456) $ Net 20,260 435 3,708 24,403 900 25,303 Core deposit intangible assets are amortized using an accelerated method over the estimated remaining life of the acquired core deposits. As of December 31, 2005, these assets had a weighted average remaining life of approximately eight years. Unidentifiable intangible assets related to branch acquisitions are amortized on a straight-line basis over ten years. Non-compete intangible assets are being amortized on a straight-line basis over five years, which is the term of the underlying contracts. Amortization expense related to intangible assets totaled $5.3 million, $4.7 million and $2.1 million in 2005, 2004 and 2003, respectively. Amortization expense for the next five years is expected to be as follows (in thousands): Year 2006 .................. $ 2007 .................. 2008 .................. 2009 .................. 2010 .................. 5,692 5,115 4,276 3,790 3,215 NOTE G – MORTGAGE SERVICING RIGHTS The following table summarizes the changes in mortgage servicing rights (MSR’s), which are included in other assets in the consolidated balance sheets: 2005 2004 (in thousands) 2003 Balance at beginning of year................................ $ Originations of mortgage servicing rights............ Amortization expense........................................... Balance at end of year .......................................... $ 8,157 1,548 (2,190) 7,515 $ $ 8,396 2,138 (2,377) 8,157 $ $ 6,233 4,992 (2,829) 8,396 MSR’s represent the economic value to be derived by the Corporation based upon its existing contractual rights to service mortgage loans that have been sold. Accordingly, to the extent mortgage loan prepayments occur the value of MSR’s can be impacted. The Corporation estimates the fair value of its MSR’s by discounting the estimated cash flows of servicing revenue, net of costs, over the expected life of the underlying loans at a discount rate commensurate with the risk associated with these assets. Expected life is based on industry prepayment projections for mortgage-backed securities with rates and terms comparable to the loans underlying the MSR’s. The estimated fair value of MSR’s was approximately $8.8 million and $8.5 million at December 31, 2005 and 2004, respectively. 48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fulton Financial Corporation Estimated MSR amortization expense for the next five years, based on balances at December 31, 2005 and the expected remaining lives of the underlying loans follows (in thousands): Year 2006 .................. $ 2007 .................. 2008 .................. 2009 .................. 2010 .................. 1,779 1,594 1,381 1,139 864 NOTE H – DEPOSITS Deposits consisted of the following as of December 31: 2005 2004 (in thousands) Noninterest-bearing demand .................................................................. $ 1,672,637 Interest-bearing demand ......................................................................... 1,637,007 Savings and money market accounts ..................................................... 2,125,475 Time deposits ......................................................................................... 3,369,720 $ 8,804,839 $ 1,507,799 1,501,476 1,917,203 2,969,046 $ 7,895,524 Included in time deposits were certificates of deposit equal to or greater than $100,000 of $749.6 million and $536.0 million at December 31, 2005 and 2004, respectively. The scheduled maturities of time deposits as of December 31, 2005 were as follows (in thousands): Year 2006 .................. $ 1,894,744 742,115 2007 .................. 227,303 2008 .................. 94,241 2009 .................. 116,806 2010 .................. 294,511 Thereafter.......... $ 3,369,720 49 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE I – SHORT-TERM BORROWINGS AND LONG-TERM DEBT Short-term borrowings at December 31, 2005, 2004, and 2003 and the related maximum amounts outstanding at the end of any month in each of the three years then ended are presented below. The securities underlying the repurchase agreements remain in available for sale investment securities. 2005 December 31 2004 2003 Maximum Outstanding 2004 2003 2005 (in thousands) Federal funds purchased ...................................... $ 939,096 352,937 Securities sold under agreements to repurchase .. 2,000 FHLB overnight repurchase agreements ............. - Revolving line of credit ....................................... 4,929 Other .................................................................... $ 676,922 500,206 - 11,930 5,466 $ 933,000 $ 939,096 $ 849,200 708,830 - 26,000 5,807 408,697 50,000 - 5,014 573,991 2,000 33,180 13,219 $ 933,000 429,819 50,000 - 6,387 $ 1,298,962 $ 1,194,524 $ 1,396,711 In 2004, the Corporation entered into a $50.0 million revolving line of credit agreement with an unaffiliated bank that provides for interest to be paid on outstanding balances at the one-month London Interbank Offering Rate (LIBOR) plus 0.27%. There was no balance outstanding on the line at December 31, 2005. The credit agreement requires the Corporation to maintain certain financial ratios related to capital strength and earnings. The Corporation was in compliance with all required covenants under the credit agreement as of December 31, 2005. The following table presents information related to securities sold under agreements to repurchase: 2005 December 31 2004 (dollars in thousands) 2003 Amount outstanding at December 31 ............................ $ 352,937 Weighted average interest rate at year end .................... Average amount outstanding during the year ................ $ 435,922 Weighted average interest rate during the year ............. 2.12% 2.61% $ 500,206 $ 408,697 1.03% 0.72% $ 531,196 $ 351,302 0.97% 0.83% Federal Home Loan Bank advances and long-term debt included the following as of December 31: Federal Home Loan Bank advances ....................................................... $ 717,037 40,724 Junior subordinated deferrable interest debentures ................................ 100,000 Subordinated debt................................................................................... 2,584 Other long-term debt, including unamortized issuance costs................. $ 860,345 $ 645,461 34,022 - 4,753 $ 684,236 2005 2004 (in thousands) Excluded from the preceding table is the Parent Company’s revolving line of credit with its subsidiary banks ($61.4 million and $70.5 million outstanding at December 31, 2005 and 2004, respectively). This line of credit is secured by equity securities and insurance investments and bears interest at the prime rate. Although the line of credit and related interest have been eliminated in consolidation, this borrowing arrangement is senior to the subordinated debt and the junior subordinated deferrable interest debentures. In March 2005 the Corporation issued $100.0 million of ten-year subordinated notes, which mature April 1, 2015 and carry a fixed rate of 5.35%. Interest is paid semi-annually in October and April of each year. 50 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fulton Financial Corporation The Parent Company owns all of the common stock of six Subsidiary Trusts, which have issued Trust Preferred Securities in conjunction with the Parent Company issuing junior subordinated deferrable interest debentures to the trusts. The terms of the junior subordinated deferrable interest debentures are the same as the terms of the Trust Preferred Securities. The Parent Company’s obligations under the debentures constitute a full and unconditional guarantee by the Parent Company of the obligations of the trusts. The Trust Preferred Securities are redeemable on specified dates, or earlier if the deduction of interest for Federal income taxes is prohibited, the Trust Preferred Securities no longer qualify as Tier I regulatory capital, or if certain other contingencies arise. The Trust Preferred Securities must be redeemed upon maturity. The following table details the terms of the debentures (dollars in thousands): Debentures Issued to Premier Capital Trust ............... PBI Capital Trust II.................. Resource Capital Trust II ......... Resource Capital Trust III........ Bald Eagle Statutory Trust I..... Bald Eagle Statutory Trust II ... Fixed/ Variable Fixed Variable Variable Variable Variable Variable Rate at December 31, 2005 Amount Maturity Callable 8.57 % 7.79 % 8.42 % 7.79 % 7.82 % 7.97 % $ $ 10,310 15,464 5,155 3,093 4,124 2,578 40,724 8/15/2028 11/7/2032 12/8/2031 11/7/2032 7/31/2031 6/26/2032 8/15/2008 11/7/2007 12/8/2006 11/7/2007 7/31/2006 6/26/2007 In January 2006, the Corporation purchased all of the common stock of a new Subsidiary Trust, Fulton Capital Trust I, which was formed for the purpose of issuing $150.0 million of trust preferred securities at a fixed rate of 6.29% and an effective rate of approximately 6.50% as a result of issuance costs. In connection with this transaction the Parent Company issued $154.6 million of junior subordinated deferrable interest debentures to the trust. These debentures carry the same rate and mature on February 1, 2036. Federal Home Loan Bank advances mature through March 2027 and carry a weighted average interest rate of 4.38%. As of December 31, 2005, the Corporation had an additional borrowing capacity of approximately $1.5 billion with the Federal Home Loan Bank. Advances from the Federal Home Loan Bank are secured by Federal Home Loan Bank stock, qualifying residential mortgages, investments and other assets. The following table summarizes the scheduled maturities of Federal Home Loan Bank advances and long-term debt as of December 31, 2005 (in thousands): Year 2006 .................. $ 2007 .................. 2008 .................. 2009 .................. 2010 .................. Thereafter.......... 33,734 72,367 216,915 48,470 79,768 409,091 $ 860,345 NOTE J – REGULATORY MATTERS Dividend and Loan Limitations The dividends that may be paid by subsidiary banks to the Parent Company are subject to certain legal and regulatory limitations. Under such limitations, the total amount available for payment of dividends by subsidiary banks was approximately $240 million at December 31, 2005. 51 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Under current Federal Reserve regulations, the subsidiary banks are limited in the amount they may loan to their affiliates, including the Parent Company. Loans to a single affiliate may not exceed 10%, and the aggregate of loans to all affiliates may not exceed 20% of each bank subsidiary's regulatory capital. At December 31, 2005, the maximum amount available for transfer from the subsidiary banks to the Parent Company in the form of loans and dividends was approximately $320 million. Regulatory Capital Requirements The Corporation’s subsidiary banks are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory – and possibly additional discretionary – actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the subsidiary banks must meet specific capital guidelines that involve quantitative measures of the subsidiary banks' assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The subsidiary banks' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the subsidiary banks to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets (as defined in the regulations). Management believes, as of December 31, 2005, that all of its bank subsidiaries meet the capital adequacy requirements to which they are subject. As of December 31, 2005 and 2004, the Corporation's four significant subsidiaries, Fulton Bank, Lafayette Ambassador Bank, The Bank and Resource Bank were well capitalized under the regulatory framework for prompt corrective action based on their capital ratio calculations. To be categorized as well-capitalized, these banks must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since December 31, 2005 that management believes have changed the institutions' categories. The following tables present the total risk-based, Tier I risk-based and Tier I leverage requirements for the Corporation and its significant subsidiaries with total assets in excess of $1.0 billion. As of December 31, 2005 Actual Amount Ratio For Capital Adequacy Purposes Ratio Amount (dollars in thousands) Well-Capitalized Ratio Amount Total Capital (to Risk-Weighted Assets): Corporation .................................................. $ 1,102,891 409,653 Fulton Bank.................................................. 102,007 Lafayette Ambassador Bank ........................ 101,532 The Bank ...................................................... 105,343 Resource Bank ............................................. Tier I Capital (to Risk-Weighted Assets): Corporation .................................................. $ 910,044 323,466 Fulton Bank.................................................. 85,331 Lafayette Ambassador Bank ........................ 80,820 The Bank ...................................................... 86,825 Resource Bank ............................................. Tier I Capital (to Average Assets): Corporation .................................................. $ 910,044 323,466 Fulton Bank.................................................. 85,331 Lafayette Ambassador Bank ........................ 80,820 The Bank ...................................................... 86,825 Resource Bank ............................................. 52 12.1% $ 730,115 8.0% $ 912,644 369,191 11.1 88,173 11.6 92,456 11.0 88,482 11.9 295,353 8.0 70,539 8.0 73,965 8.0 70,786 8.0 10.0% 10.0 10.0 10.0 10.0 10.0% $ 365,057 4.0% $ 547,586 221,515 52,904 55,474 53,089 147,676 4.0 35,269 4.0 36,983 4.0 35,393 4.0 8.8 9.7 8.7 9.8 7.7% $ 355,090 3.0% $ 591,817 228,462 7.1 60,821 7.0 57,676 7.0 55,194 7.9 137,077 3.0 36,492 3.0 34,606 3.0 33,116 3.0 6.0% 6.0 6.0 6.0 6.0 5.0% 5.0 5.0 5.0 5.0  Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2004 Actual Amount Ratio For Capital Adequacy Purposes Ratio Amount (dollars in thousands) Well-Capitalized Ratio Amount Total Capital (to Risk-Weighted Assets): Corporation ...................................................... $ 981,000 401,961 Fulton Bank...................................................... Lafayette Ambassador Bank ............................ 95,631 89,891 The Bank .......................................................... Resource Bank ................................................. 83,274 Tier I Capital (to Risk-Weighted Assets): Corporation ...................................................... $ 888,526 366,633 Fulton Bank...................................................... 86,456 Lafayette Ambassador Bank ............................ 81,252 The Bank .......................................................... Resource Bank ................................................. 75,503 Tier I Capital (to Average Assets): Corporation ...................................................... $ 888,526 366,633 Fulton Bank...................................................... 86,456 Lafayette Ambassador Bank ............................ 81,252 The Bank .......................................................... 75,503 Resource Bank ................................................. NOTE K – INCOME TAXES The components of the provision for income taxes are as follows: 11.8% 11.2 11.4 11.1 11.1 10.6% 10.2 10.3 10.0 10.0 $ 667,522 8.0% 286,697 8.0 67,124 8.0 64,969 8.0 60,241 8.0 $ 834,402 358,372 83,905 81,211 75,302 10.0% 10.0 10.0 10.0 10.0 $ 333,761 4.0% 143,349 4.0 33,562 4.0 32,485 4.0 30,121 4.0 $ 500,641 215,023 50,343 48,727 45,181 8.8% 8.4 7.4 7.7 7.7 $ 304,392 3.0% 130,290 3.0 35,166 3.0 31,762 3.0 29,304 3.0 $ 507,319 217,150 58,609 52,937 48,839 6.0% 6.0 6.0 6.0 6.0 5.0% 5.0 5.0 5.0 5.0 Current tax expense: Federal.................................................................... $ State........................................................................ Deferred tax expense ................................................... $ 2005 Year ended December 31 2004 (in thousands) 2003 69,611 760 70,371 990 71,361 $ $ 63,440 417 63,857 816 64,673 $ $ 53,342 1,277 54,619 4,465 59,084 The differences between the effective income tax rate and the Federal statutory income tax rate are as follows: Year ended December 31 2004 2003 2005 Statutory tax rate ......................................................... Effect of tax-exempt income ....................................... Effect of low income housing investments.................. State income taxes, net of Federal benefit................... Other............................................................................ Effective income tax rate............................................. 35.0% (2.8) (2.1) 0.2 (0.2) 30.1% 35.0% (2.9) (2.1) 0.1 0.1 30.2% 35.0% (3.3) (2.1) 0.4 0.2 30.2% 53 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The net deferred tax asset recorded by the Corporation is included in other assets and consists of the following tax effects of temporary differences at December 31: Deferred tax assets: Allowance for loan losses.................................................................. $ Unrealized holding losses on securities available for sale ................ Deferred compensation...................................................................... LIH Investments ................................................................................ Post-retirement benefits..................................................................... Other accrued expenses ..................................................................... Stock-based compensation ................................................................ Other than temporary impairment of investments ............................. Derivative financial instruments........................................................ Other.................................................................................................. Total gross deferred tax assets...................................................... Deferred tax liabilities: Direct leasing..................................................................................... Intangible assets and acquisition premiums/discounts ...................... Mortgage servicing rights.................................................................. Premises and equipment .................................................................... Other.................................................................................................. Total gross deferred tax liabilities ................................................ 2005 2004 (in thousands) $ 32,496 21,592 7,234 3,318 3,225 2,412 1,867 1,400 1,177 153 74,874 9,357 8,679 2,653 747 5,601 27,037 31,370 5,155 6,072 2,724 3,403 1,549 1,797 1,022 - 1,541 54,633 10,038 5,014 2,855 2,003 2,522 22,432 Net deferred tax asset ................................................................... $ 47,837 $ 32,201 The Corporation has net operating losses (NOL’s) for income taxes in certain states that are eligible for carryforward credit against future taxable income for a specific number of years. The Corporation does not anticipate generating taxable income in these states during the carryforward years and, as such, deferred tax assets have not been recognized for these NOL’s. As of December 31, 2005 and 2004, the Corporation had not established any valuation allowance against net Federal deferred tax assets since these tax benefits are realizable either through carryback availability against prior years' taxable income or the reversal of existing deferred tax liabilities. Based on the Corporation’s historical and projected net income, a valuation allowance is not considered necessary. NOTE L – EMPLOYEE BENEFIT PLANS Substantially all eligible employees of the Corporation are covered by one of the following plans or combination of plans: Profit Sharing Plan – A noncontributory defined contribution plan where employer contributions are based on a formula providing for an amount not to exceed 15% of each eligible employee’s annual salary (10% for employees hired subsequent to January 1, 1996). Participants are 100% vested in balances after five years of eligible service. In addition, the profit sharing plan includes a 401(k) feature which allows employees to defer a portion of their pre-tax salary on an annual basis, with no employer match. Contributions under this feature are 100% vested. Defined Benefit Pension Plans and 401(k) Plans – Contributions to the Corporation’s defined benefit pension plan (Pension Plan) are actuarially determined and funded annually. Pension Plan assets are invested in money markets, fixed income securities, including corporate bonds, U.S. Treasury securities and common trust funds, and equity securities, including common stocks and common stock mutual funds. The Pension Plan has been closed to new participants, but existing participants continue to accrue benefits according to the terms of the plan. 54 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fulton Financial Corporation Employees covered under the Pension Plan are also eligible to participate in the Fulton Financial Affiliates 401(k) Savings Plan, which allows employees to defer a portion of their pre-tax salary on an annual basis. At its discretion, the Corporation may also make a matching contribution up to 3%. Participants are 100% vested in the Corporation’s matching contributions after three years of eligible service. The following summarizes the Corporation's expense under the above plans for the years ended December 31: Profit Sharing Plan....................................................... $ Pension Plan................................................................. 401(k) Plan................................................................... $ 2005 2004 (in thousands) 2003 7,801 3,468 1,376 12,645 $ $ 8,251 3,072 967 12,290 $ $ 6,606 3,025 596 10,227 The net periodic pension cost for the Corporation's Pension Plan, as determined by consulting actuaries, consisted of the following components for the years ended December 31: 2005 2004 (in thousands) 2003 Service cost .................................................................. $ Interest cost .................................................................. Expected return on assets............................................. Net amortization and deferral ...................................... Net periodic pension cost............................................. $ 2,486 3,370 (3,273) 885 3,468 $ $ 2,307 3,102 (3,001) 664 3,072 $ $ 2,178 2,952 (2,631) 526 3,025 The measurement date for the Pension Plan is September 30. The following table summarizes the changes in the projected benefit obligation and fair value of plan assets for the indicated periods: Plan Year Ended September 30 2005 2004 (in thousands) Projected benefit obligation, beginning.................................................. $ 59,265 $ 52,282 Service cost ............................................................................................ Interest cost ............................................................................................ Benefit payments .................................................................................... Actuarial loss.......................................................................................... Experience (gain) loss ............................................................................ 2,486 3,370 (1,673) 959 (767) 2,307 3,102 (1,270) 2,552 292 Projected benefit obligation, ending....................................................... $ 63,640 Fair value of plan assets, beginning ....................................................... $ 41,468 $ $ 59,265 37,980 Employer contributions .......................................................................... Actual return on assets ........................................................................... Benefit payments .................................................................................... 10,652 3,010 (1,673) 2,622 2,136 (1,270) Fair value of plan assets, ending ............................................................ $ 53,457 $ 41,468 55 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The funded status of the Pension Plan and the amounts included in the consolidated balance sheets as of December 31 follows: 2005 2004 (in thousands) Projected benefit obligation.................................................................... $ Fair value of plan assets ......................................................................... Funded status..................................................................................... (63,640) $ 53,457 (10,183) (59,265) 41,468 (17,797) Unrecognized net transition asset........................................................... Unrecognized prior service cost ............................................................. Unrecognized net loss ............................................................................ Intangible asset ....................................................................................... Accumulated other comprehensive loss ................................................. Pension asset (liability) recognized in the consolidated balance sheets............................................................... $ (38) 72 15,254 - - 5,105 Accumulated benefit obligation ............................................................. $ 50,434 (51) 82 15,687 (82) (858) $ $ (3,019) 44,487 Accumulated other comprehensive income was reduced by $858,000 ($558,000, net of tax) as of December 31, 2004 to increase the pension liability to an amount equal to the difference between the accumulated benefit obligation and the fair value of plan assets. This adjustment was reversed in 2005 as a result of the Corporation making a $10.7 million contribution to the plan in September 2005. The following rates were used to calculate net periodic pension cost and the present value of benefit obligations: Discount rate-projected benefit obligation ................... Rate of increase in compensation level ........................ Expected long-term rate of return on plan assets ......... 2005 5.50% 4.00 8.00 2004 5.75% 4.50 8.00 2003 6.00% 4.50 8.00 The 5.50% discount rate used to calculate the present value of benefit obligations is determined using published long-term AA corporate bond rates as of the measurement date, rounded to the nearest 0.25%. The 8.0% long-term rate of return on plan assets used to calculate the net periodic pension cost is based on historical returns. Total returns for 2005, 2004 and 2003 approximated this rate. The expected long-term return is considered to be appropriate based on the asset mix and the historical returns realized. The following table summarizes the weighted average asset allocations as of September 30: Cash and equivalents..................................................... 17.0% Equity securities ............................................................ Fixed income securities................................................. 44.0 39.0 2005 2004 6.0% 50.0 44.0 Total ......................................................................... 100.0% 100.0% 56  Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Equity securities consist mainly of equity common trust and mutual funds. Fixed income securities consist mainly of fixed income common trust funds. Defined benefit plan assets are invested with a balanced growth objective, with target asset allocations between 40 and 70 percent for equity securities and 30 to 60 percent for fixed income securities. The Corporation expects to contribute $4.1 million to the pension plan in 2006. Estimated future benefit payments are as follows (in thousands): Year 2006.................. $ 2007.................. 2008.................. 2009.................. 2010.................. 2011 – 2015...... 1,458 1,495 1,597 1,761 1,992 14,587 $ 22,890 Post-retirement Benefits The Corporation currently provides medical benefits and a death benefit to certain retired full-time employees who were employees of the Corporation prior to January 1, 1998. Certain full-time employees may become eligible for these discretionary benefits if they reach retirement age while working for the Corporation. Benefits are based on a graduated scale for years of service after attaining the age of 40. The components of the expense for post-retirement benefits other than pensions are as follows: 2005 Service cost ................................... .............................. $ Interest cost ................................... .............................. Expected return on plan assets ..................................... Net amortization and deferral....................................... Net post-retirement benefit cost .... .............................. $ 406 524 (5) (226) 699 $ 2004 (in thousands) $ 2003 $ $ 281 446 (2) (287) 438 364 474 (2) (230) 606 The following table summarizes the changes in the accumulated post-retirement benefit obligation and fair value of plan assets for the years ended December 31: 2005 2004 (in thousands) Accumulated post-retirement benefit obligation, beginning .................. $ 8,929 $ 7,815 Service cost ............................................................................................ Interest cost ............................................................................................ Benefit payments .................................................................................... Change due to change in experience ...................................................... Change due to change in assumptions.................................................... 406 524 (359) 419 930 Accumulated post-retirement benefit obligation, ending ....................... $ 10,849 Fair value of plan assets, beginning ....................................................... $ Employer contributions .......................................................................... Actual return on assets ........................................................................... Benefit payments .................................................................................... 150 350 5 (359) 364 474 (268) 296 248 8,929 165 251 2 (268) $ $ Fair value of plan assets, ending ............................................................ $ 146 $ 150 57 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The funded status of the plan and the amounts included in other liabilities as of December 31 follows: 2005 2004 (in thousands) Accumulated post-retirement benefit obligation ................................. $ Fair value of plan assets ...................................................................... Funded status.................................................................................. (10,849) $ 146 (10,703) Unrecognized prior service cost .......................................................... Unrecognized net loss (gain)............................................................... Post-retirement benefit liability recognized in the consolidated balance sheets.................................................. $ (453) 1,311 (9,845) $ (9,497) (8,929) 150 (8,779) (679) (39) For measuring the post-retirement benefit obligation, the annual increase in the per capita cost of health care benefits was assumed to be 9.0% in year one, declining to an ultimate rate of 4.5% by year nine. This health care cost trend rate has a significant impact on the amounts reported. Assuming a 1.0% increase in the health care cost trend rate above the assumed annual increase, the accumulated post-retirement benefit obligation would increase by approximately $1.4 million and the current period expense would increase by approximately $141,000. Conversely, a 1% decrease in the health care cost trend rate would decrease the accumulated post-retirement benefit obligation by approximately $1.2 million and the current period expense by approximately $115,000. The discount rate used in determining the accumulated post-retirement benefit obligation, which is determined using published long- term AA corporate bond rates as of the measurement date, rounded to the nearest 0.25%, was 5.50% at December 31, 2005 and 5.75% at December 31, 2004. The expected long-term rate of return on plan assets was 3.00% at December 31, 2005 and 2004. NOTE M – STOCK-BASED COMPENSATION PLANS AND SHAREHOLDERS' EQUITY Statement 123R requires that the fair value of equity awards to employees be recognized as compensation expense over the period during which an employee is required to provide service in exchange for such award. During the third quarter of 2005, the Corporation adopted Statement 123R using “modified retrospective application”, electing to restate all prior periods including all per- share amounts. The principal accounts impacted by the restatement were salaries and employee benefits expense, additional paid-in capital, retained earnings, other assets and taxes. The Corporation’s equity awards consist of stock options and restricted stock granted under its Stock Option and Compensation Plans (Option Plans) and shares purchased by employees under its Employee Stock Purchase Plan (ESPP). 58 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the impact of modified retrospective application on the previously reported results for the periods shown: Fulton Financial Corporation 2004 2003 (in thousands, except per-share data) Income before income taxes, originally reported ................. $ Stock-based compensation expense under the fair value 218,181 $ 197,543 method (1)....................................................................... Income before income taxes, restated................................... $ (3,900) 214,281 (2,092) 195,451 $ Net income, originally reported............................................ $ Stock-based compensation expense under the fair value 152,917 $ 138,180 method, net of tax (1)...................................................... Net income, restated ............................................................. $ (3,309) 149,608 Net income per share (basic), originally reported (2).......... $ Net income per share (basic), restated.................................. 1.02 1.00 Net income per share (diluted), originally reported (2)........ $ Net income per share (diluted), restated ............................... 1.01 0.99 $ $ $ (1,813) 136,367 0.98 0.97 0.98 0.96 (1) Stock-based compensation expense, originally reported, was $0. (2) Originally reported amounts have been restated for the impact of the 5-for-4 stock split paid in June 2005. As a result of the retrospective adoption of Statement 123R, as of January 1, 2003 retained earnings decreased $11.4 million, additional paid-in capital increased $12.5 million and deferred tax assets increased $1.1 million. These changes reflect a combination of compensation expense for prior stock option grants to employees and related tax benefits. The following table presents compensation expense and related tax benefits for equity awards recognized in the consolidated income statements: Compensation expense................................................................. $ Tax benefit ................................................................................... Net income effect ......................................................................... $ 1,041 (321) 720 $ $ 3,900 (591) 3,309 $ $ 2,092 (279) 1,813 2005 2004 (in thousands) 2003 The tax benefit shown in the preceding table is less than the benefit that would be calculated using the Corporation’s 35% statutory Federal tax rate. Under Statement 123R, tax benefits are recognized upon grant only for options that ordinarily will result in a tax deduction when exercised (non-qualified stock options). The Corporation granted 440,000, 607,000 and 260,000 non-qualified stock options in 2005, 2004 and 2003, respectively. Compensation expense and tax benefits for restricted stock awards for the year ended December 31, 2005, included in the preceding table, were $270,000 and $94,000, respectively. Under the Option Plans, stock options are granted to key employees for terms of up to ten years at option prices equal to the fair market value of the Corporation's stock on the date of grant. Options are typically granted annually on July 1st and, prior to the July 1, 2005 grant, had been 100% vested immediately upon grant. For the July 1, 2005 grant, a three-year cliff-vesting feature was added and, as a result, compensation expense associated with this grant will be recognized over the three-year vesting period. This change in vesting resulted in a significant decrease in stock-based compensation expense in 2005 as compared to 2004. On July 1, 2005, 15,000 59 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS shares of restricted stock with a five-year cliff-vesting period were granted to one employee. Certain events as defined in the Option Plans result in the acceleration of the vesting of both the stock options and restricted stock. As of December 31, 2005, the Option Plans had 14.9 million shares reserved for future grants through 2013. The following table provides information about options outstanding for the year ended December 31, 2005: Stock Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term Aggregate Intrinsic Value (in millions) Outstanding at December 31, 2004.... Granted ............................................ Exercised ......................................... Assumed from SVB Financial ......... Forfeited........................................... Outstanding at December 31, 2005.... 6,591,053 1,092,500 (1,051,719) 166,218 (20,364) 6,777,688 $ 10.74 17.98 7.50 13.08 16.53 $ 12.45 6.2 years $34.9 Exercisable at December 31, 2005 .... 5,677,828 $ 11.42 5.5 years $35.1 The following table provides information about nonvested options and restricted stock for the year ended December 31, 2005: Stock Options Restricted Stock Weighted Average Grant Date Fair Value Shares Weighted Average Grant Date Fair Value Options Nonvested at December 31, 2004 ...... Granted............................................. Vested............................................... Forfeited ........................................... Nonvested at December 31, 2005 ...... - 1,092,500 - (7,800) 1,084,700 $ - 2.52 - 2.52 2.52 $ - 15,000 - - 15,000 $ - 17.98 - - $ 17.98 As of December 31, 2005, there was $2.1 million of total unrecognized compensation cost related to nonvested stock options that will be recognized as compensation expense over a weighted average period of 2.5 years. The following table presents information about options exercised: 2005 2004 (dollars in thousands) 2003 Number of options exercised...................................... Total intrinsic value of options exercised................... $ Cash received from options exercised........................ $ Tax deduction realized from options exercised.......... $ 1,051,719 1,388,773 10,675 $ 6,774 $ 7,049 $ 13,577 $ 6,341 $ 6,936 $ 532,181 4,503 2,216 1,960 Upon exercise, the Corporation issues shares from its authorized, but unissued, common stock to satisfy the options. 60  Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The fair value of option awards under the Option Plans is estimated on the date of grant using the Black-Scholes valuation methodology, which is dependent upon certain assumptions, as summarized in the following table. Risk-free interest rate ............................................................... Volatility of Corporation’s stock ............................................. Expected dividend yield........................................................... Expected life of options ........................................................... 3.76% 16.17 3.23 6 Years 4.22% 18.12 3.22 7 Years 3.55% 22.75 3.22 8 Years 2005 2004 2003 The expected life of the options was estimated based on historical employee behavior and represents the period of time that options granted are expected to be outstanding. Volatility of the Corporation’s stock was based on historical volatility for the period commensurate with the expected life of the options. The risk-free interest rate is the U.S. Treasury rate commensurate with the expected life of the options on the date of the grant. Based on the assumptions used in the model, the Corporation calculated an estimated fair value per option of $2.52, $2.78 and $3.07 for options granted in 2005, 2004 and 2003, respectively. Approximately 1.1 million, 1.3 million and 601,000 options were granted in 2005, 2004 and 2003, respectively. The fair value of restricted stock awards is equal to the fair market value of the Corporation's stock on the date of grant. Under the ESPP, eligible employees can purchase stock of the Corporation at 85% of the fair market value of the stock on the date of purchase. The ESPP is considered to be a compensatory plan under Statement 123R and, as such, compensation expense is recognized for the 15% discount on shares purchased. The following table summarizes activity under the ESPP for the indicated periods. ESPP shares purchased ........................................................... Average purchase price per share (85% of market value) ...... $ Compensation expense recognized (in thousands) ................. $ 130,946 14.82 341 105,392 14.55 $ 271 $ 108,380 12.82 $ 245 $ 2005 2004 2003 Shareholder Rights On June 20, 1989, the Board of Directors of the Corporation declared a dividend of one common share purchase right (Original Rights) for each outstanding share of common stock, par value $2.50 per share, of the Corporation. The dividend was paid to the shareholders of record as of the close of business on July 6, 1989. On April 27, 1999, the Board of Directors approved an amendment to the Original Rights and the rights agreement. The significant terms of the amendment included extending the expiration date from June 20, 1999 to April 27, 2009 and resetting the purchase price to $90.00 per share. As of December 31, 2005, the purchase price had adjusted to $43.08 per share as a result of stock dividends. The Rights are not exercisable or transferable apart from the common stock prior to distribution. Distribution of the Rights will occur ten business days following (1) a public announcement that a person or group of persons (Acquiring Person) has acquired or obtained the right to acquire beneficial ownership of 20% or more of the outstanding shares of common stock (the Stock Acquisition Date) or (2) the commencement of a tender offer or exchange offer that would result in a person or group beneficially owning 25% or more of such outstanding shares of common stock. The Rights are redeemable in full, but not in part, by the Corporation at any time until ten business days following the Stock Acquisition Date, at a price of $0.01 per Right. Treasury Stock The Corporation periodically repurchases shares of its common stock under repurchase plans approved by the Board of Directors. These repurchases have historically been through open market transactions and have complied with all regulatory restrictions on the timing and amount of such repurchases. Shares repurchased have been added to treasury stock and are accounted for at cost. These shares are periodically reissued for various corporate needs. 61 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In 2005, the Corporation purchased 4.3 million shares of its common stock from an investment bank at a total cost of $73.6 million under an “Accelerated Share Repurchase” program (ASR), which allowed the shares to be purchased immediately rather than over time. The investment bank, in turn, repurchased shares on the open market over a period that was determined by the average daily trading volume of the Corporation’s shares, among other factors. The Corporation completed the ASR in February of 2006 and settled its position with the investment bank by paying $3.4 million, representing the difference between the initial prices paid and the actual price of the shares repurchased. Total treasury stock purchases, including both open market purchases and ASR’s, were approximately 5.0 million shares in 2005, 4.7 million shares in 2004 and 4.0 million shares in 2003. NOTE N – LEASES Certain branch offices and equipment are leased under agreements that expire at varying dates through 2035. Most leases contain renewal provisions at the Corporation's option. Total rental expense was approximately $12.1 million in 2005, $9.4 million in 2004 and $6.4 million in 2003. Future minimum payments as of December 31, 2005 under noncancelable operating leases are as follows (in thousands): Year 2006.................. $ 2007.................. 2008.................. 2009.................. 2010.................. Thereafter ......... $ 10,437 9,593 7,763 6,222 5,107 33,186 72,308 NOTE O – COMMITMENTS AND CONTINGENCIES The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit and interest rate risk that are not recognized in the consolidated balance sheets. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments is expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income producing commercial properties. Standby letters of credit are conditional commitments issued to guarantee the financial or performance obligation of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation underwrites these obligations using the same criteria as its commercial lending underwriting. The Corporation’s maximum exposure to loss for standby letters of credit is equal to the contractual (or notional) amount of the instruments. 62 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table presents the Corporation’s commitments to extend credit and letters of credit: Fulton Financial Corporation 2005 2004 (in thousands) Commercial mortgage, construction and land development ......... $ 829,769 Home equity.................................................................................. 494,872 Credit card..................................................................................... 382,415 Commercial and other ................................................................... 2,028,997 Total commitments to extend credit......................................... $ 3,736,053 $ 689,818 412,790 384,504 1,851,159 $ 3,338,271 Standby letters of credit ................................................................ $ 599,191 Commercial letters of credit.......................................................... 23,037 Total letters of credit ................................................................ $ 622,228 $ 533,094 24,312 $ 557,406 From time to time, the Corporation and its subsidiary banks may be defendants in legal proceedings relating to the conduct of their banking business. Most of such legal proceedings are a normal part of the banking business, and in management's opinion, the financial position and results of operations and cash flows of the Corporation would not be affected materially by the outcome of such legal proceedings. During the first quarter of 2006, a legal settlement was reached in a lawsuit against Resource Bank, a wholly owned subsidiary of Fulton Financial. The suit alleged Resource Bank violated the Telephone Consumer Protection Act (TCPA), prior to being acquired by Fulton Financial in April 2004. The settlement resulted in a $2.2 million charge to other expense for the year ended December 31, 2005. The settlement is subject to court approval. 63 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE P – FAIR VALUE OF FINANCIAL INSTRUMENTS The following are the estimated fair values of the Corporation's financial instruments as of December 31, 2005 and 2004, followed by a general description of the methods and assumptions used to estimate such fair values. These fair values are significantly affected by assumptions used, principally the timing of future cash flows and the discount rate. Because assumptions are inherently subjective in nature, the estimated fair values cannot be substantiated by comparison to independent market quotes and, in many cases, the estimated fair values could not necessarily be realized in an immediate sale or settlement of the instrument. Further, certain financial instruments and all non-financial instruments are excluded. Accordingly, the aggregate fair value amounts presented do not necessarily represent management's estimation of the underlying value of the Corporation. FINANCIAL ASSETS Cash and due from banks .................... $ Interest-bearing deposits with other banks ............................. Federal funds sold ............................... Loans held for sale............................... Securities held to maturity (1) ............. Securities available for sale (1) ........... Net loans.............................................. Accrued interest receivable ................. 2005 2004 Book Value Estimated Fair Value Book Value (in thousands) Estimated Fair Value 368,043 $ 368,043 $ 278,065 $ 278,065 31,404 528 243,378 18,258 31,404 528 243,378 18,317 2,543,887 2,543,887 8,424,728 8,322,514 53,261 53,261 4,688 32,000 209,504 25,001 2,424,858 7,533,915 40,633 4,688 32,000 209,504 25,413 2,424,858 7,619,104 40,633 FINANCIAL LIABILITIES Demand and savings deposits............. $ 5,435,119 $ 5,435,119 $ 4,926,478 $ 4,926,478 2,974,551 Time deposits...................................... 1,194,524 Short-term borrowings........................ 27,279 Accrued interest payable .................... Other financial liabilities .................... 29,640 Federal Home Loan Bank advances and long-term debt........................ 3,346,911 1,298,962 38,604 41,643 3,369,720 1,298,962 38,604 41,643 2,969,046 1,194,524 27,279 29,640 710,215 684,236 860,345 871,429 (1) See Note C, “Investment Securities”, for detail by security type. For short-term financial instruments, defined as those with remaining maturities of 90 days or less, the carrying amount was considered to be a reasonable estimate of fair value. The following instruments are predominantly short-term: Assets Cash and due from banks Interest bearing deposits Federal funds sold Accrued interest receivable Loans held for sale Liabilities Demand and savings deposits Short-term borrowings Accrued interest payable Other financial liabilities For those components of the above-listed financial instruments with remaining maturities greater than 90 days, fair values were determined by discounting contractual cash flows using rates which could be earned for assets with similar remaining maturities and, in the case of liabilities, rates at which the liabilities with similar remaining maturities could be issued as of the balance sheet date. 64  Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As indicated in Note A, “Summary of Significant Accounting Policies”, securities available for sale are carried at their estimated fair values. The estimated fair values of securities held to maturity as of December 31, 2005 and 2004 were generally based on quoted market prices, broker quotes or dealer quotes. For short-term loans and variable rate loans that reprice within 90 days, the carrying value was considered to be a reasonable estimate of fair value. For other types of loans, fair value was estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. In addition, for loans secured by real estate, appraisal values for the collateral were considered in the fair value determination. The fair value of long-term debt was estimated by discounting the remaining contractual cash flows using a rate at which the Corporation could issue debt with a similar remaining maturity as of the balance sheet date. The fair value of commitments to extend credit and standby letters of credit is estimated to equal their carrying amounts. NOTE Q – MERGERS AND ACQUISITIONS Completed Acquisitions On July 1, 2005, the Corporation completed its acquisition of SVB Financial Services, Inc. (SVB). SVB was a $530 million bank holding company whose primary subsidiary was Somerset Valley Bank (Somerset Valley), which operates thirteen community-banking offices in Somerset, Hunterdon and Middlesex Counties in New Jersey. Under the terms of the merger agreement, each of the approximately 4.1 million shares of SVB’s common stock was acquired by the Corporation based on a “cash election merger” structure. Each SVB shareholder elected to receive 100% of the merger consideration in stock, 100% in cash, or a combination of stock and cash. As a result of the SVB shareholder elections, approximately 3.2 million of the SVB shares outstanding on the acquisition date were converted into shares of Corporation common stock, based on a fixed exchange ratio of 1.1899 shares of Corporation stock for each share of SVB stock. The remaining 983,000 shares of SVB stock were purchased for $21.00 per share. In addition, each of the options to acquire SVB’s stock was converted into options to purchase the Corporation’s stock or was settled in cash, based on the election of each option holder and the terms of the merger agreement. The total purchase price was $90.4 million, including $66.6 million in stock issued and stock options assumed, $22.4 million of SVB stock purchased and options settled for cash and $1.4 million for other direct acquisition costs. The purchase price for shares issued was determined based on the value of the Corporation’s stock on the date when the number of shares was fixed and determinable. As a result of the acquisition, SVB was merged into the Corporation and Somerset Valley became a wholly owned subsidiary. The acquisition was accounted for using purchase accounting, which required the Corporation to allocate the total purchase price of the acquisition to the assets acquired and liabilities assumed, based on their respective fair values at the acquisition date, with any remaining purchase price being recorded as goodwill. Resulting goodwill balances are then subject to an impairment test on at least an annual basis. The results of Somerset Valley’s operations are included in the Corporation’s financial statements prospectively from the July 1, 2005 acquisition date. 65 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following is a summary of the purchase price allocation based on estimated fair values on the acquisition date (in thousands): Cash and due from banks............................................................... $ Other earning assets ...................................................................... Investment securities available for sale ......................................... Loans, net of allowance ................................................................. Premises and equipment ............................................................... Core deposit intangible asset ......................................................... Trade name intangible asset........................................................... Goodwill ........................................................................................ Other assets.................................................................................... Total assets acquired.................................................................. Deposits ......................................................................................... Long-term debt .............................................................................. Other liabilities .............................................................................. Total liabilities assumed ............................................................ 20,035 61,046 124,916 301,660 9,345 8,476 380 54,417 10,608 590,883 473,490 24,710 2,290 500,490 Net assets acquired .................................................................... $ 90,393 On December 31, 2004, the Corporation completed its acquisition of First Washington FinancialCorp (First Washington), of Windsor, New Jersey. First Washington was a $490 million bank holding company whose primary subsidiary was First Washington State Bank, which operates sixteen community-banking offices in Mercer, Monmouth, and Ocean Counties in New Jersey. The total purchase price was $126.0 million including $125.2 million in stock issued and options assumed and $729,000 in First Washington stock purchased for cash and other direct acquisition costs. The Corporation issued 1.69 shares of its stock for each of the 4.3 million shares of First Washington outstanding on the acquisition date. The purchase price was determined based on the value of the Corporation’s stock on the date when the final terms of the acquisition were agreed to and announced. On April 1, 2004, the Corporation completed its acquisition of Resource Bankshares Corporation (Resource), an $890 million financial holding company, and its primary subsidiary, Resource Bank. Resource Bank is located in Virginia Beach, Virginia, and operates six community-banking offices in Newport News, Chesapeake, Herndon, Virginia Beach and Richmond, Virginia and fourteen loan production and residential mortgage offices in Virginia, North Carolina, Maryland and Florida. The total purchase price was $195.7 million, including $185.9 million in stock issued and options assumed, and $9.8 million in Resource stock purchased for cash and other direct acquisition costs. The Corporation issued 1.925 shares of its stock for each of the 5.9 million shares of Resource outstanding on the acquisition date. The purchase price was determined based on the value of the Corporation’s stock on the date when the final terms of the acquisition were agreed to and announced. 66 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes unaudited pro-forma information assuming the acquisitions of SVB, First Washington and Resource had occurred on January 1, 2004. This pro-forma information includes certain adjustments, including amortization related to fair value adjustments recorded in purchase accounting (in thousands, except per-share information): Fulton Financial Corporation 2005 2004 Net interest income .......... $ Other income.................... Net income ....................... 420,644 145,128 167,178 Per Share: Net income (basic) ........ $ Net income (diluted) ..... 1.06 1.04 $ $ 397,007 149,029 155,523 0.97 0.95 Subsequent Event - Acquisition On February 1, 2006, the Corporation completed its acquisition of Columbia Bancorp (Columbia), of Columbia, Maryland. Columbia was a $1.3 billion bank holding company whose primary subsidiary was The Columbia Bank, which operates 19 full-service community banking offices and five retirement community offices in Howard, Montgomery, Prince George’s and Baltimore Counties and Baltimore City. Under the terms of the merger agreement, each of the approximately 6.9 million shares of Columbia’s common stock was acquired by the Corporation based on a “cash election merger” structure. Each Columbia shareholder elected to receive 100% of the merger consideration in stock, 100% in cash, or a combination of stock and cash. As a result of Columbia shareholder elections, approximately 3.5 million of the Columbia shares outstanding on the acquisition date were converted into shares of the Corporation common stock, based upon a fixed exchange ratio of 2.325 shares of Corporation stock for each share of Columbia stock. The remaining 3.4 million shares of Columbia stock were purchased for $42.48 per share. In addition, each of the options to acquire Columbia’s stock was converted into options to purchase the Corporation’s stock or was settled in cash, based on the election of each option holder and the terms of the merger agreement. The total purchase price was approximately $302 million, including $150.1 million in stock issued and stock options assumed, $150.4 million of Columbia stock purchased and options settled for cash and $1.4 million for other direct acquisition costs. The purchase price for shares issued was determined based on the value of the Corporation’s stock on the date when the number of shares was fixed and determinable. As a result of the acquisition, Columbia was merged into the Corporation and The Columbia Bank became a wholly owned subsidiary. The acquisition is being accounted for using purchase accounting, which requires the Corporation to allocate the total purchase price of the acquisition to the assets acquired and liabilities assumed, based on their respective fair values at the acquisition date, with any remaining acquisition cost being recorded as goodwill. Resulting goodwill balances are then subject to an impairment review on at least an annual basis. The carrying value of Columbia’s net assets as of February 1, 2006 was approximately $98.4 million. The Corporation is in the process of determining the fair value of the net assets acquired and expects to have a preliminary purchase price allocation completed by the end of the first quarter of 2006. The results of Columbia’s operations will be included in the Corporation’s financial statements prospectively from the date of the acquisition. 67 Fulton Financial Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE R – CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY CONDENSED BALANCE SHEETS (in thousands) December 31 2005 2004 December 31 2005 2004 ASSETS Cash, securities, and other assets ........................ $ Receivable from subsidiaries......... 8,852 $ 10 6,740 777 Investment in: Bank subsidiaries ..................... Non-bank subsidiaries.............. 1,203,927 355,343 1,183,856 250,901 Total Assets .............................. $ 1,568,132 $ 1,442,274 LIABILITIES AND EQUITY Line of credit with bank subsidiaries....................... $ 61,388 $ Revolving line of credit ................. - Long-term debt .............................. 140,121 Payable to non-bank subsidiaries... 43,674 Other liabilities .............................. 39,978 Total Liabilities......................... 285,161 Shareholders’ equity ...................... 1,282,971 Total Liabilities and Shareholders’ Equity .............. $ 1,568,132 $ 1,442,274 70,500 11,930 34,955 48,117 32,685 198,187 1,244,087 CONDENSED STATEMENTS OF INCOME 2005 Year ended December 31 2004 (in thousands) 2003 Income: Dividends from bank subsidiaries ................................................................................. $ 223,900 Other.............................................................................................................................. 45,336 269,236 66,824 Expenses............................................................................................................................. Income before income taxes and equity in undistributed net income of subsidiaries....................................................................... Income tax benefit.............................................................................................................. $ 62,131 40,227 102,358 58,563 $ 149,596 38,206 187,802 50,272 202,412 (8,445) 210,857 43,795 (6,420) 50,215 137,530 (4,177) 141,707 Equity in undistributed net income (loss) of: Bank subsidiaries .......................................................................................................... (53,640) Non-bank subsidiaries................................................................................................... 8,857 Net Income ............................................................................................................... $ 166,074 84,525 14,868 $ 149,608 (20,879) 15,539 $ 136,367 68 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fulton Financial Corporation CONDENSED STATEMENTS OF CASH FLOWS Cash Flows From Operating Activities: Net Income .................................................................................................... $ 166,074 $ 149,608 $ 136,367 2005 Year Ended December 31 2004 (in thousands) 2003 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Stock-based compensation.............................................................................. (Increase) decrease in other assets ................................................................ Equity in undistributed net loss (income) of subsidiaries............................... (Decrease) increase in other liabilities and payable to non-bank subsidiaries ................................................................ Total adjustments ...................................................................................... Net cash provided by operating activities ................................................. Cash Flows From Investing Activities: Investment in bank subsidiaries ..................................................................... Investment in non-bank subsidiaries .............................................................. Net cash paid for acquisitions ........................................................................ Net cash used in investing activities ......................................................... Cash Flows From Financing Activities: Net (decrease) increase in borrowings ........................................................... Dividends paid .............................................................................................. Net proceeds from issuance of common stock .............................................. Increase in long-term debt.............................................................................. Acquisition of treasury stock ........................................................................ Net cash used in financing activities .......................................................... 1,041 (1,381) 44,783 (2,653) 41,790 207,864 (3,700) (100,000) (21,724) (125,424) (21,042) (85,495) 10,991 98,342 (85,168) (82,372) 3,900 (13,004) (99,393) 36,859 (71,638) 77,970 (6,000) - (5,283) (11,283) 79,552 (74,802) 7,537 - (78,966) (66,679) Net Increase (Decrease) in Cash and Cash Equivalents ........................... Cash and Cash Equivalents at Beginning of Year ................................... Cash and Cash Equivalents at End of Year .............................................. Cash paid during the year for: Interest ....................................................................................................... Income taxes ............................................................................................... 68 8 76 8 - $ 8 2,758 60,539 $ 2,889 54,457 $ $ $ $ 2,092 1,255 5,340 (4,098) 4,589 140,956 (3,500) - (1,544) (5,044) (16,678) (64,628) 5,087 - (59,699) (135,918) (6) 6 - 2,469 48,924 69 Fulton Financial Corporation Management Report on Internal Control Over Financial Reporting The management of Fulton Financial Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. Fulton Financial Corporation’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework. Based on this assessment, management concluded that, as of December 31, 2005, the company’s internal control over financial reporting is effective based on those criteria. Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which is included herein. R. Scott Smith, Jr. Chairman, Chief Executive Officer and President Charles J. Nugent Senior Executive Vice President and Chief Financial Officer 70 Fulton Financial Corporation Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Fulton Financial Corporation: We have audited management's assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting appearing on page 70, that Fulton Financial Corporation maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Fulton Financial Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that Fulton Financial Corporation maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Fulton Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). 71 Fulton Financial Corporation We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Fulton Financial Corporation and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders’ equity and comprehensive income, and cash flows for each of the years in the three- year period ended December 31, 2005, and our report dated March 9, 2006 expressed, an unqualified opinion on those consolidated financial statements. Harrisburg, Pennsylvania March 9, 2006 72 Fulton Financial Corporation Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Fulton Financial Corporation: We have audited the accompanying consolidated balance sheets of Fulton Financial Corporation and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fulton Financial Corporation and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Fulton Financial Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 9, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting. Harrisburg, Pennsylvania March 9, 2006 73 Fulton Financial Corporation QUARTERLY CONSOLIDATED RESULTS OF OPERATIONS (UNAUDITED) (in thousands, except per-share data) FOR THE YEAR 2005 Interest income ......................... Interest expense ........................ Net interest income................... Provision for loan losses........... Other income ............................ Other expenses.......................... Income before income taxes..... Income taxes ............................. Net income................................ Per-share data: Net income (basic)............... Net income (diluted)............ Cash dividends..................... FOR THE YEAR 2004 Interest income ......................... Interest expense ........................ Net interest income................... Provision for loan losses........... Other income ............................ Other expenses.......................... Income before income taxes..... Income taxes ............................. Net income................................ Per-share data: Net income (basic)............... Net income (diluted)............ Cash dividends..................... Three Months Ended March 31 June 30 Sept. 30 Dec. 31 $ 140,810 42,562 98,248 800 35,853 73,828 59,473 18,037 41,436 $ $ 148,611 48,686 99,925 725 38,315 78,189 59,326 17,722 41,604 $ $ 164,113 57,617 106,496 815 36,152 81,537 60,296 18,168 42,128 $ $ 172,263 64,354 107,909 780 33,948 82,737 58,340 17,434 40,906 $ $ $ 0.26 0.26 0.132 0.27 0.27 0.145 $ 0.27 0.27 0.145 $ 0.26 0.26 0.145 $ 113,936 30,969 82,967 1,740 32,038 62,344 50,921 15,147 35,774 $ $ 122,024 33,318 88,706 800 36,663 70,598 53,971 16,167 37,804 $ $ 126,947 34,446 92,501 1,125 34,993 74,036 52,333 16,324 36,009 $ $ 130,736 37,261 93,475 1,052 35,170 70,537 57,056 17,035 40,021 $ $ $ 0.25 0.25 0.122 0.25 0.24 0.132 $ 0.24 0.23 0.132 $ 0.27 0.26 0.132 74 Fulton Financial Corporation (This page intentionally left blank) 75 Fulton Financial Corporation (This page intentionally left blank) 76 

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